Question

Wyoming Corporation produces heavy equipment for military applications. As part of this process, it currently manufactures a fuel valve; the cost of the valve is indicated below:

		unit cost
variable costs
direct materials		$900
direct labor		$530
variable overhead		$240
total variable costs		1,670
fixed costs
equipt. Depreciation		$300
building depreciation		$100
supervisory salaries		$100
total fixed cost		$500
total unit cost		$2,170

The company has an offer from an outside valve manufacturer to produce the part for $1,850 per unit and supply 1,000 valves (the number needed in the coming year).

If the company accepts this offer and shuts down production of valves, production workers and supervisors will be reassigned to other areas needing their services.

The equipment cannot be used elsewhere in the company, and it has no market value.

The space occupied by the production of the valve can, however, be used by another production group of the company that is currently leasing space for $41,000 per year.

REQUIRED:

What are the costs involved should they decide to outsource the production of the valves?

What are the benefits involved should they decide to outsource the production of the valves?

Should they outsource the production of the valves or continue to manufacture them?

In negotiating with the outside vendor, what is the MAXIMUM price that the company could offer the outside manufacturer without losing money on this decision.

List and explain TWO qualitative factors that the company might address as part of this decision.

Answer 1

a) Costs involved in outsourcing:

Cost to outsource	$1,850
Equipment depreciation	$300
Total cost	$2,150

b) Benefits of outsourcing

Savings in costs:
Direct material	$900
Direct labor	$530
variable overhead	$240
building depreciation	$100
supervisor salaries	$100
Total benefits	$1,870

c) They should outsource the production of valves becuase the total cost of outsourcing is $2150 whereas the total cost to manufacture is $2170. so there is a saving of $20.

d) The maximum price the company could offer is $1870 which is calculated as (2170 - 300)

e) Two qualitative factors that the company should address would include the quality of the valve produced by the other company. If there is a compromise in the quality, it wil lead to losses for the company.

The second factor would be timing of providing the valves. The outsourcing firm should be able to provide the valves on time so that there is no loss sale.