Question

Hospital Oxygen Delivery Systems Incorporated (HODS) manufactures a variety of continuous oxygen delivery systems for infants, children, and adults. The company is currently manufacturing all of its own components parts including electronic sensors, a key component of continuous oxygen delivery systems.      An outside supplier has offered to sell the electronic sensor to HODS for $20 per unit. To evaluate this offer, HODS has gathered the following information relating to its own cost of producing the electronic sensor internally:

	Per Unit	15,000 Units per Year
Direct materials	$6	$ 90,000
Direct labor	8	120,000
Variable manufacturing overhead	1	15,000
Fixed manufacturing overhead, traceable	5*	75,000
Fixed manufacturing overhead, common, but allocated	10	150,000
Total cost	$30	$450,000
*40% supervisory salaries; 60% depreciation of special equipment. If the outside supplier’s offer is accepted, the special equipment would be scrapped.

Required:

1. Assuming that the company has no alternative use for the facilities now being used to produce the electronic sensor, should the outside supplier’s offer be accepted? Show all computations

2. Suppose that if the electronic sensors were purchased, HODS could use the freed capacity to launch a new product. The segment margin of the new product would be $65,000 per year. Should HODS accept the offer to buy the electronic sensors from the outside supplier for $20 each? Show computations.

Answer 1

1	Assuming the company has no alternative use for the facilities now being used to produce the most, should outside supplier offer be accepted?
		Per unit Differential costs		For 15000 units
		Make	Buy	Make	Buy
	Cost of purchasing		$20		300000
	Direct Materials	$6		90000
	Direct labor	$8		120000
	Variable manufacturing overhead	$1		15000
	Fixed Manufacturing overhead, traceable [$5*40%]	$2		30000
	Fixed common manufacturing overhead	$0
	Total costs	$17	$20	255000	300000

Based on above calculation, company should produce products internally.

2	Suppose that if the thermostats were purchased, climate control Inc could use the freed capacity to launch a new product?
		Make	Buy
	Cost of purchasing		300000
	cost of Making	255000
	Oppurtunity cost	65000
	Total cost	320000	300000

Based on above calculation company should buy product from outside as it saves $20000 for the company