Question

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Morning Sky, Inc. (MSI), manufactures and sells computer games. The company has several product lines based on the age range of the target market. MSI sells both individual games as well as packaged sets. All games are in CD format, and some utilize accessories such as steering wheels, electronic tablets, and hand controls. To date, MSI has developed and manufactured all the CDs itself as well as the accessories and packaging for all of its products.

The gaming market has traditionally been targeted at teenagers and young adults; however, the increasing affordability of computers and the incorporation of computer activities into junior high and elementary school curriculums has led to a significant increase in sales to younger children. MSI has always included games for younger children but now wants to expand its business to capitalize on changes in the industry. The company currently has excess capacity and is investigating several possible ways to improve profitability.

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 24,000 units of the module per year for $27.00 each. The following information pertains to MSI’s production of the control modules:

Direct materials	$	13
Direct labor		6
Variable manufacturing overhead		7
Fixed manufacturing overhead		7
Total cost per unit	$	33

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 $30,000 in annual profit. Recompute the difference in cost between making and buying under this scenario.

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

Answer 1

Answer 1:

The difference in cost between making and buying the control module = $ 24,000

Calculations:

Statement of Comparative Cost
Buy the parts	Amount	Make the parts	Amount
Purchase Cost (24,000 * 27)	$ 648,000	Direct material (24000*13)	$ 312,000
		Direct Labor (24000*6)	$ 144,000
		variable Manufacturing overheads (24000*7)	$ 168,000
Total cost	$648,000	Total cost	$624,000

Answer 2:

MSI should make the products.

Answer 3a:

The difference in cost between making and buying = $ 6,000

Working note:

Statement of Comparative Cost
Buy the parts	Amount	Make the parts	Amount
Purchase Cost (24,000 * 27)	$ 648,000	Direct material (24000*13)	$ 312,000
Less: Benefit	$ (30,000)	Direct Labor (24000*6)	$ 144,000
		variable Manufacturing overheads (24000*7)	$ 168,000
Total cost	$618,000	Total cost	$624,000

Answer 3b:

This change is recommended to MSI.

MSI should buy the modules.

In case of any doubt, please comment.