Question

MSI is considering outsourcing the production of the handheld control module used with some of its products. The company has received a bid from Monte Legend Co. (MLC) to produce 16,000 units of the module per year for $36.00 each. The following information pertains to MSI’s production of the control modules:

Direct materials $ 19

Direct labor 9

Variable manufacturing overhead 7

Fixed manufacturing overhead 2

Total cost per unit $ 37

MSI has determined that it could eliminate all variable costs if the control modules were produced externally, but none of the fixed overhead is avoidable. At this time, MSI has no specific use in mind for the space that is currently dedicated to the control module production.

Required:

1. Compute the difference in cost between making and buying the control module.

2. Should MSI buy the modules from MLC or continue to make them? Make Buy

3-a. Suppose that the MSI space currently used for the modules could be utilized by a new product line that would generate $38,000 in annual profit. Recompute the difference in cost between making and buying under this scenario.

3-b. Does this change your recommendation to MSI? No Yes

Answer 1

Answer 1.
	Make	Buy	Net Income Increase (Decrease)
Direct Materials - 16,000 units X $19	304,000.00	-	304,000.00
Direct Labor - 16,000 units X $9	144,000.00	-	144,000.00
Variable Overhead - 16,000 units X $7	112,000.00	-	112,000.00
Fixed Overhead - 16,000 units X $2	32,000.00	32,000.00	-
Purchase Cost - 16,000 units X $36	-	576,000.00	(576,000.00)
Total Cost	592,000.00	608,000.00	(16,000.00)
Answer 2.
MSI should Make the Control Module
Answer 3-a.
	Make	Buy	Net Income Increase (Decrease)
Direct Materials - 16,000 units X $19	304,000.00	-	304,000.00
Direct Labor - 16,000 units X $9	144,000.00	-	144,000.00
Variable Overhead - 16,000 units X $7	112,000.00	-	112,000.00
Fixed Overhead - 16,000 units X $2	32,000.00	32,000.00	-
Purchase Cost - $2.75 X 50,000 Nos	-	576,000.00	(576,000.00)
Additional Income - Realeased Productive Capacity		(38,000.00)	38,000.00
Total Cost	592,000.00	570,000.00	22,000.00
Answer 3-b.
MSI should buy the Control Module