Question

RRA 12: Make vs Buy Decisions / Opportunity Cost

The Nomad Company produces small, portable Bluetooth speakers. This year’s expected production is 10,000 units. Currently, Nomad makes the chips used in its speakers. Nomad’s management accountant reports the following costs for making the 10,000 chips:

	Cost per unit	Cost per 10,000 units
Direct materials	$4.00	$40,000
Direct manufacturing labor	2.00	20,000
Variable manufacturing overhead (power and utilities)	1.50	15,000
Inspection, setup, materials handling		2,000
Machine rent		3,000
Allocated fixed costs of plant administration, taxes, and insurance		30,000
Total Costs		110,000

Nomad has received an offer from an outside vendor to supply any number of chips Nomad requires at $8.20 per chip. The following additional information is available:

• Inspection, setup, and materials-handling costs vary with the number of batches in which the chips are produced. Nomad produces chips in batch sizes of 1,000 units. Nomad estimates that it will produce the 10,000 units in 10 batches.

• Nomad rents the machine used to make the chips. If Nomad buys all of its chips from the outside vendor, it does not need to pay rent on this machine.

Requirements

1. Assume that if Nomad purchases the chips from the outside supplier, the facility where the chips are currently made will remain idle. On the basis of financial considerations alone, should Nomad accept the outside supplier’s offer at the anticipated production (and sales) volume of 10,000 units? Show your calculations.

2. For this question, assume that if the chips are purchased outside, the facilities where the chips are currently made will be used to upgrade the chips by increasing the memory capacity from 1 gigabyte to 10 gigabytes. As a consequence, the selling price of its Bluetooth speakers is expected to increase by $20. The variable cost per unit of the upgrade is anticipated to be $18, and additional tooling costs of $16,000 would be incurred. On the basis of financial considerations alone, should Nomad make or buy the chips, assuming that 10,000 units are produced (and sold)? Show your calculations. 2

3. The sales manager at Nomad is concerned that the estimate of 10,000 units might be high and believes that only 6,200 units will be sold. Production will be cut back, freeing up work space. This space can be used to upgrade the chips whether Nomad goes outside for the chips or makes them in-house. At this lower output level, Nomad will produce the chips in eight batches of 775 units each. On the basis of financial considerations alone, should Nomad purchase the chips from the outside vendor? Show your calculations.

Answer 1