Question

V & T Faces, Inc., is a makeup company. They currently produce small plastic containers used to provide samples of the products. Management is interested in outsourcing the production of the plastic containers to a reputable manufacturing company that can supply the containers for $0.04 each. V & T Faces, Inc., incurs the following monthly production costs to produce 1,000,000 plastic containers internally:

	Per unit	Total monthly costs at 1,000,000 units
Variable production cost	0.02	20,000
Fixed production cost		25,000
Total production cost		45,000

If production is outsourced, all variable production costs and 70 percent of fixed production costs will be eliminated.

Required:

Perform differential analysis. Assume making the containers internally is Alternative 1 and buying the containers from an outside manufacturer is Alternative 2.

• Which alternative is best? Explain.
• Summarize the result of outsourcing production of the containers.
• Assume all the facts of this problem remain the same. However, management of V & T Faces, Inc., has an opportunity to lease the space it currently uses to produce containers for $4,000 per month if production of the containers is outsourced. Determine if V & T Faces, Inc., would be better off outsourcing production.
• Identify at least one qualitative factor that should be considered before management decides to outsource production of the containers.

Answer 1

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Part 1
		Alternative 1	Alternative 2	Difference
Variable Cost		$             20,000	$                      -	$        20,000
Fixed Cost		$             25,000	$               7,500	$        17,500
Purchase Price	1,000,000*$0.04		$             40,000	$      -40,000
Total Cost		$             45,000	$             47,500	$         -2,500
Its better to make internally since cost is lower.
Part 2
		Alternative 1	Alternative 2	Difference
Variable Cost		$             20,000	$                      -	$        20,000
Fixed Cost		$             25,000	$               7,500	$        17,500
Purchase Price	1,000,000*$0.04		$             40,000	$      -40,000
Opportunity Cost		$               4,000		$          4,000
Total Cost		$             49,000	$             47,500	$          1,500
Its better to outsource since cost is lower in alternative 2