FDR Corp. estimates it will produce 30,000 units of a part that goes into its fi

Question

FDR Corp. estimates it will produce 30,000 units of a part that goes into its final product. It currently produces this part internally, but is considering outsourcing this activity. Current internal capacity permits for a maximum of 60,000 units of the part. The production manager has prepared the following information concerning the internal manufacture of 60,000 units of the part: Per unit Direct materials $3.00 Direct labor 4.00 Variable overhead 5.00 Fixed overhead 6.00 Total cost $18.00 The fixed overhead of $6 per unit includes a $1.50 per unit allocation for salary paid to a supervisor to oversee production of the part. The fixed costs would not be reduced by outsourcing, except the supervisor would be terminated. Assume that if FDR outsources, its purchase price from the oursourcer is $12 per unit. REQUIRED: a. Should FDR outsource? Provide support for your answer. b. Assume FDR has received a special order for 10,000 units of the part from Alpha Corp.   Alpha will pay FDR $23 per part, but will take the parts only if they have been manufactured by FDR. Thus, Alpha will engage in the special order only if FDR does not outsource any of its production. Should FDR accept the special order? Explain why or why not. FDR Corp. estimates it will produce 30,000 units of a part that goes into its final product. It currently produces this part internally, but is considering outsourcing this activity. Current internal capacity permits for a maximum of 60,000 units of the part. The production manager has prepared the following information concerning the internal manufacture of 60,000 units of the part: Per unit Direct materials $3.00 Direct labor 4.00 Variable overhead 5.00 Fixed overhead 6.00 Total cost $18.00 The fixed overhead of $6 per unit includes a $1.50 per unit allocation for salary paid to a supervisor to oversee production of the part. The fixed costs would not be reduced by outsourcing, except the supervisor would be terminated. Assume that if FDR outsources, its purchase price from the oursourcer is $12 per unit. REQUIRED: a. Should FDR outsource? Provide support for your answer. b. Assume FDR has received a special order for 10,000 units of the part from Alpha Corp.   Alpha will pay FDR $23 per part, but will take the parts only if they have been manufactured by FDR. Thus, Alpha will engage in the special order only if FDR does not outsource any of its production. Should FDR accept the special order? Explain why or why not.

Explanation / Answer

a) Yes, FDR should oursource the part as it stands to save $90000 for the 30000 units that it needs. The $90000 savings in costs is the differential cost for outsourcing the parts as shown below: Total cost for 30000 units if produced if outsourced Differential costs for internally outsourcing direct materials 90000 0 -90000 direct labor 120000 0 -120000 variable overhead 150000 0 -150000 fixed overhead 0 6*60000 360000 -360000 4.5*60000 270000 270000 purchase cost - 12*30000 360000 360000 720000 630000 -90000 b) FDR should accept the special order as it brings contribution of $110000 which will reduce the effective cost of the 30000 units produced and used internally. The effective cost of 30000 uits will be 610000 as worked out below: Net cost of producing 40000 units and selling 10000 units of the special order: Cost of producing 30000 units for internal consumption 720000 Less: contribution from 10000 units of the special order 110000 (10000*23-12) Net cost for 30000 units 610000 If FDR purchases the 30000 units from ouside and does not take the special order, the 30000 units will cost $630000 (including fixed costs that continue after outsourcng) Hence, by accepting the special order and producing the entire 40000 units internally FDR will benefit by $20000 (630000 - 610000)

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