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).
$Answer

Answer 1

Answer a

Note :

1. If Mountain Air accepts the offer, the variable labor and variable overhead costs of the auto air purifier will be reduce by 50 % . Further by accepting the offer the company will also save the cost of assembling the motors. All these amount to saving of cost if Mountain Air accepts the offer of Mini Motor Company.
2. Variable overhead costs per unit of an auto air purifier = Factory overhead - Fixed overhead = $7 - ( $40,000 / 10,000 units) = $3

Calculation of the net advantage (disadvantage) of outsourcing the motors

Particular	Amount ($)	Amount ($)
Purchase cost (10,000 units * $4.50)		-45,000
Less saving in cost
Variable labor cost ( 10,000 units * $1.50 * 50 %)	7,500
Variable overhead cost (10,000 units * $3* 50 %)	15,000
Cost of assembles the motors (10,000 units * $1)	10,000	32,500
Net advantage (disadvantage) of outsourcing the motors		-12,500

Conclusion : Since the company will incure $12,500 more by outsourcing the motors , thus it is better to continue with assembling the motors.

Answer b

Calculation of the net advantage (disadvantage) of outsourcing the motors & renting the space

Particular	Amount ($)	Amount ($)
Purchase cost (10,000 units * $4.50)		-45,000
Less saving in cost
Variable labor cost ( 10,000 units * $1.50 * 50 %)	7,500
Variable overhead cost (10,000 units * $3* 50 %)	15,000
Cost of assembles the motors (10,000 units * $1)	10,000	32,500
Revenue from renting the space		28,000
Net advantage (disadvantage) of outsourcing the motors		$15,500

Conclusion : Since the company will save $15,500 by outsourcing the motors , thus it is better to outsource motors from Mini Motor Company.