2. Suppose that the space Mohave currently uses to make the bags could be utiliz

Question

2. Suppose that the space Mohave currently uses to make the bags could be utilized by a new product line that would generate $13,000 in annual profits. Recompute the difference in cost between making and buying the umbrella tote bag.

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 9,800 units per year for $9.5 each Mohave has the following information about its own production of the tote bags: $5 Direct materials Direct labor Fixed manufacturing overhead Total cost per unit $10 Mohave has determined that all variable costs could be eliminated by dropping production of the tote bags, while 75 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 Favors Making

Explanation / Answer

By comparing the cost to produce umbrella tote bag :

Cost of production in mohave corp. = 10

Buying cost from wilow co=9.5

(1) Mohave will be indifferent between buying and making tote bags when the total costs for making and buying will be equal at the volume level where:

Variable cost per unit x no.of units+avoidable fixed cost=buying cost per unit x no.of units

Let u be the no of units

(5+2+1)u + 25%(2*9800)= 9.5 u

1.5u = 4900; u=3267 units

As volume of production drops the average pee unit cost of in hoise production increases. If volume falls below 3267units then mohave shall prefer to buy the tote bags from willow co.

(2) if the space Mohave currently uses to make the bags could be utilized by a new product line that would generate $13,000 in annual profits then mohave would face an opportunity cost associated with in house tote bags production for the 9800 units of 1.33 per unit

New cost to make =8+1.33=9.33

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