Question

MSI is considering outsourcing the production of the handheld control module used with some of its products. The company has received a bid from Monte Legend Co. (MLC) to produce 25,000 units of the module per year for $22.00 each. The following information pertains to MSI’s production of the control modules:

Direct materials	$	13
Direct labor		6
Variable manufacturing overhead		2
Fixed manufacturing overhead		8
Total cost per unit	$	29

MSI has determined that it could eliminate all variable costs if the control modules were produced externally, but none of the fixed overhead is avoidable. At this time, MSI has no specific use in mind for the space that is currently dedicated to the control module production.

Required:
1. Compute the difference in cost between making and buying the control module.

2. Should MSI buy the modules from MLC or continue to make them?

3-a. Suppose that the MSI space currently used for the modules could be utilized by a new product line that would generate $41,000 in annual profit. Recompute the difference in cost between making and buying under this scenario.

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

If there could be an explination that would be great

Answer 1

1		Make Product	Buy Product	Difference
	Direct Materials	$                 3,25,000		$                      3,25,000
	Direct labor	$                 1,50,000		$                      1,50,000
	Variable Manufacturing Overhead	$                    50,000		$                         50,000
	Purchase Cost	$                           -	$                                 5,50,000	$                    -5,50,000
	Total Cost to make/Buy	$                 5,25,000	$                                 5,50,000	$                       -25,000
	So the difference in making and Buying of product is $25,000 in favour of Making
2	MSI should make the product as it is more cost effective
3.a		Make Product	Buy Product	Difference
	Direct Materials	$                 3,25,000		$                      3,25,000
	Direct labor	$                 1,50,000		$                      1,50,000
	Variable Manufacturing Overhead	$                    50,000		$                         50,000
	Purchase Cost	$                           -	$                                 5,50,000	$                    -5,50,000
	Utilization of Space	$                           -	$                                   -41,000	$                         41,000
	Total Cost to make/Buy	$                 5,25,000	$                                 5,09,000	$                         16,000
3.b	Due to the Utilization of Space the Net cost to Buy is less than the cost to manufacture, Hence company should now buy the product