Question

Mohave Corp. is considering outsourcing production of the umbrella tote bag included with some of its products. The company has received a bid from a supplier in Vietnam to produce 8,400 units per year for $7.00 each. Mohave has the following information about the cost of producing tote bags:

Direct materials $ 3

Direct labor 2

Variable manufacturing overhead 1

Fixed manufacturing overhead 1.50

Total cost per unit $ 7.50

Mohave has determined that all variable costs could be eliminated by outsourcing the tote bags, while 60 percent of the fixed overhead cost is unavoidable. At this time, Mohave has no specific use in mind for the space currently dedicated to producing the tote bags.

Required:

1. Compute the difference in cost between making and buying the umbrella tote bag.

2. Should Mohave buy the tote bags or continue to make them?

Make Buy

3-a. Suppose that the space Mohave currently uses to make the bags could be utilized by a new product line that would generate $12,000 in annual profits. Recompute the difference in cost between making and buying the umbrella tote bag.

3-b. Does this change your recommendation to Mohave?

Yes No

Answer 1

Differential cost
			Make	Buy	Difference
Direct material		25200	0	25200
Direct labour		16800	0	16800
Variable Mfg oh		8400	0	8400
Fixed Mfg oh		12600	7560	5040
Cost of Purchase		0	58800	-58800
Total cost			63000	66360	-3360
Net Difference in cost of making and buying: ($ 3360)
Yes, the Company shall continue to make them
Req 3.
Differential cost
			Make	Buy	Difference
Direct material		25200	0	25200
Direct labour		16800	0	16800
Variable Mfg oh		8400	0	8400
Fixed Mfg oh		12600	7560	5040
Opportunity cost -Profit	12000	0	12000
Cost of Purchase		0	58800	-58800
Total cost			75000	66360	8640
Net Difference in cost of making and buying: $ 8640
Yes, the company shall buy the component from Supplier