Mohave Corp. is considering outsourcing production of the umbrella tote bag incl

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 Willow Co. to produce 9,300 units per year for $7.5 each. Mohave has the following information about its own production of the tote bags:

Mohave Corp. is considering outsourcing production of the umbrella tote bag included with some of its products. The company has received a bid from Willow Co. to produce 9,300 units per year for $7.5 each. Mohave has the following information about its own production of the tote bags:

Direct materials Direct labor Variable manufacturing overhead Fixed manufacturing overhead $4 Total cost per unit $8 Mohave has determined that all variable costs could be eliminated by dropping production of 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

Explanation / Answer

1) Cost of buying = $7.5

Cost of making = $4 + $1 + $1 +( $2*30%)

= 6.60

Unavoidable fixed cost will continue to occur, hence ignored in decision making

Making

Buying

Differential cost of making versus buying

$ 6.6

$ 7.5

2. Mohave continue to make then = MAKE

3-a) if space use for making would generate annual profit = $11000, then net cost of buying = cost – benefit achieved

= $7.5 – ($11000/9300)

= 6.32

3-b) yes, this change our recommendation to Mohave… now buying is better option

Making

Buying

Differential cost of making versus buying

$ 6.6

$ 7.5

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