Question

Mohave Corp. is considering outsourcing production of the umbrella tote bag included with some of its products. The company has received a bid from a supplier in Vietnam to produce 9,000 units per year for $8.00 each. Mohave has the following information about the cost of producing tote bags:        

Direct materials	$	5
Direct labor		1
Variable manufacturing overhead		1
Fixed manufacturing overhead		2.00
Total cost per unit	$	9.00

Mohave has determined that all variable costs could be eliminated by outsourcing the tote bags, while 70 percent of the fixed overhead cost is unavoidable. At this time, Mohave has no specific use in mind for the space currently dedicated to producing the tote bags.

Required:
1. Compute the difference in cost between making and buying the umbrella tote bag.

	Differential Cost of Making Versus Buying

2. Should Mohave buy the tote bags or continue to make them?

buy or make

3-a. Suppose that the space Mohave currently uses to make the bags could be utilized by a new product line that would generate $5,000 in annual profits. Recompute the difference in cost between making and buying the umbrella tote bag.

	Differential Cost of Making Versus Buying

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

yes or no

Answer 1

• All working forms part of the answer
• Requirement 1

	Make option	Buy Option	Differential Cost
Direct material	$          45,000.00		$      (45,000.00)
Direct Labor	$             9,000.00		$        (9,000.00)
Variable manufacturing overhead	$             9,000.00		$        (9,000.00)
Fixed manufacturing overhead	$          18,000.00	$        12,600.00 [18000 x 70%]	$        (5,400.00)
Purchase cost		$        72,000.00	$        72,000.00
Total cost	$          81,000.00	$        84,600.00	$           3,600.00

Differential cost = $3,600

• Requirement 2

Since total cost of buying is $3,600 more than total cost of making, the Mohave SHOULD MAKE the bags.

• Requirement 3 (a)

	Make option	Buy Option	Differential Cost
Direct material	$          45,000.00		$      (45,000.00)
Direct Labor	$             9,000.00		$        (9,000.00)
variable manufacturing overhead	$             9,000.00		$        (9,000.00)
Fixed manufacturing overhead	$          18,000.00	$        12,600.00	$        (5,400.00)
Purchase cost		$        72,000.00	$        72,000.00
Additional Annual Profits		$        (5,000.00)	$        (5,000.00)
Total cost	$          81,000.00	$        79,600.00	$        (1,400.00)

Differential cost = $(1,400)

• Requirement 3 (b)

YES, now the total (net) cost of buying is $1400 less than total cost to produce, hence, now BUYING option will be recommended.