Question

Outsourcing (Make-or-Buy) Decision
Mountain Air Limited manufactures a line of room air purifiers. Management is currently evaluating the possible production of an air purifier for automobiles. Based on an annual volume of 10,000 units, the predicted cost per unit of an auto air purifier follows.

Direct materials	$8.00
Direct labor	1.50
Factory overhead	7.00
Total	$16.50

These cost predictions include $40,000 in facility-level fixed factory overhead averaged over 10,000 units.

One of the component parts of the auto air purifier is a battery-operated electric motor. Although the company does not currently manufacture these motors, the preceding cost predictions are based on the assumption that it will assemble such a motor. Mini Motor Company has offered to supply an assembled battery-operated motor at a cost of $4.50 per unit, with a minimum annual order of 5,000 units. If Mountain Air accepts this offer, it will be able to reduce the variable labor and variable overhead costs of the auto air purifier by 50 percent. The electric motor's components will cost $1.00 if Mountain Air assembles the motors.

(a) Determine whether Mountain Air should continue to make the electric motor or outsource it from Mini Motor Company.

Calculate the net advantage (disadvantage) of outsourcing the electric motors from Mini Motor Company.

Use a negative sign with your answer to indicate a net disadvantage (if applicable).
$Answer

(b) If it could otherwise rent the motor-assembly space for $28,000 per year, should it make or outsource this component?

Calculate the net advantage (disadvantage) of outsourcing the motors, assuming the space could be rented.

Use a negative sign with your answer to indicate a net disadvantage (if applicable).

***Please show the work on how you got the answer****

Answer 1

a) Fixed Factory Overhead per unit = Fixed Overhead/Annual Volume

= $40,000/10,000 units = $4 per unit

Variable Overhead cost per unit = Factory overhead - Fixed Overhead per unit

= $7.00 - $4.00 = $3.00 per unit

Reduction in cost = Reduction in Labor cost+Reduction in Variable Overhead+Saving in Assemble cost

= ($1.50*50%)+($3.00*50%)+$1.00

= $0.75+$1.50+$1.00 = $3.25

Net disadvantage of outsourcing the electric motors = (Purchase Cost - Reduction in Cost)*Units

= ($4.50 - $3.25)*10,000 = $12,500

Thus there will be a net disadvantage of -$12,500, if the production of electric motor is outsourced.

b) If it could otherwise rent the motor-assembly space for $28,000 per year, then there will be benefit of $2.80 per unit ($28,000/10,000) which will reduce the purchase cost of $4.50 per unit.

Relevant Purchase Cost = $4.50 - $2.80 = $1.70 per unit

Net advantage of outsourcing the electric motors = (Reduction in Cost - Relevant Purchase Cost)*Units

= ($3.25 - $1.70)*10,000 = $15,500

Thus there will be a net advantage of $15,500, if the production of electric motor is outsourced.