Question

Make or Buy (Outsourcing; diverting employee; relevant costs; sunk costs)

Linkage makes 12,000 chains each month. These chains are used to make other products they manufacture. For a 75-roll batch of chains, Linkage's costs are as follows:

Direct materials: $145
Direct labor: $85
Manufacturing overhead: $335
Total: $565

Within manufacturing overhead, $150 per batch is for depreciation expenses. Don't consider any other costs or expenses. An outsourcer offers to sell you 12,000 chains for $46,000. Assume that using the outsourcer won't impact your sales activities.

Given this information, provide advice to Linkage regarding accepting/rejecting the outsourcer's offer. Assume that, if you accept their offer, you must divert one of your employees to manage the outsourcer's supply chain. This employee is currently paid $51,000. You will not be paying this employee more or hiring anyone to replace this employee to handle this employee's original duties.

Now, using this same information, re-evaluate the outsourcer's offer with the following facts:
- If you accept the offer, you rent your facilities to generate $32,000 additional revenue, but will incur costs of renting of $13,000 for security

Answer 1

Part 1

Number of batch (12000/75)	160
Multiply: Depreciation expenses per batch	150
Depreciation expenses is sunk cost.	24,000
Total manufacturing overhead (335*160)	53,600
Less: Depreciation expenses	24,000
Relevant manufacturing overhead	29,600

Relevant costs of Make option
Direct materials (145*160)	23,200
Direct labor (85*160)	13,600
Relevant manufacturing overhead	29,600
Employee's monthly salary (51000/12 months)	4,250
Relevant costs of Make option	70,650
Relevant costs of Buy option
Purchase price of 12000 chains	46,000
Relevant costs of Buy option	46,000
Relevant costs of Buy option is less than make option.
Company would be buy chains from outsourcer.	Buy

Part 2: If you accept the offer, you rent your facilities to generate $32,000 additional revenue, but will incur costs of renting of $13,000 for security.

Relevant costs of Make option
Direct materials (145*160)	23,200
Direct labor (85*160)	13,600
Relevant manufacturing overhead	29,600
Employee's monthly salary (51000/12 months)	4,250
Less: net revenue from renting facilities (32000-13000)	(19,000)
Relevant costs of Make option	51,650
Relevant costs of Buy option
Purchase price of 12000 chains	46,000
Relevant costs of Buy option	46,000
Relevant costs of Buy option is less than make option.
Company would be buy chains from outsourcer.	Buy