Question

Problem 21.2A Make or Buy Decision (LO21-1, LO21-2, LO21-3, LO21-4)

Easyuse Tool Co. manufactures an electric motor that it uses in several of its products. Management is considering whether to continue manufacturing the motors or to buy them from an outside source. The following information is available.

1. The company needs 12,000 motors per year. The motors can be purchased from an outside supplier at a cost of $21 per unit.

2. The unit cost of manufacturing the motors is $35, computed as follows.

Direct materials	$	96,000
Direct labor		120,000
Factory overhead:
Variable		90,000
Fixed		114,000
Total manufacturing costs	$	420,000
Cost per unit ($420,000 ÷ 12,000 units)	$	35

3. Discontinuing the manufacture of motors will eliminate all the raw materials and direct labor costs but will eliminate only 75 percent of the variable factory overhead costs.

4. If the motors are purchased from an outside source, machinery used in the production of motors will be sold at its book value. Accordingly, no gain or loss will be recognized. The sale of this machinery would also eliminate $6,000 in fixed costs associated with depreciation and taxes. No other reductions in fixed factory overhead will result from discontinuing the production of motors.

a-1. Prepare a schedule to determine the incremental cost or benefit of buying the motors from the outside supplier.

a-2. Would you recommend that the company manufacture the motors or buy them from the outside source?

b-1. Assume that if the motors are purchased from the outside source, the factory space previously used to produce motors can be used to manufacture an additional 4,000 power trimmers per year. Power trimmers have an estimated contribution margin of $8 per unit. The manufacture of the additional power trimmers would have no effect on fixed factory overhead.

b-2. Would this new assumption change your recommendation as to whether to make or buy the motors?

Answer 1

Part a.1 and a.2
Incremental Analysis
	Make Motors	Buy Motors	Difference
Direct Materials	$                                                     96,000		$                                             96,000
Direct Labor	$                                                   120,000		$                                           120,000
Variable Factory Overhead	$                                                     90,000	$                                      22,500	$                                             67,500
Fixed Factory Overhead	$                                                   114,000	$                                    108,000	$                                               6,000
Purchase Cost	$                                                             -	$                                    252,000	$                                          -252,000
Total Manufacturing/Purchasing Cost per unit	$                                                   420,000	$                                    382,500	$                                             37,500
AS the Cost of Buying is less than the cost of Making, Hence the company should Buy the Motors
Part b.1 and b.2
Additional Contribution Margin due to Buying of Product =4000*$8 =$32,000
Now to Buy the motor there is an additional benefit of $32,000 which will further reduce the cost of purchasing by $32,000 and hence the net benefit in Buying will be $350,500
So there will be no change in decision