3. Central Coffee Co. has th e following unit costs associated with the producti

Question

3. Central Coffee Co. has th e following unit costs associated with the production of one of its products based on roasting 28,000 pounds of coffee. Direct materials (coffee) Direct materials (packaging) Direct labor Variable overhead Fixed overhead 3.00 0.30 1.00 0.20 3.00 7.50 S An independent coffee roaster has approached Central's management team and offered to roast and package the coffee for $5.75 per pound (including shipping costs). This outsourcing would allow Central to reduce total fixed overhead costs by 30%. Required: a. Should Central roast and package this product itself or should the production be outsourced to the independent roaster? (Be sure to show your supporting analysis.) Assuming the 28,000 pounds of volume, at what price per pound would Central's management be indifferent about their decision to roast and package the product themselves or outsource it? b.

Explanation / Answer

a) Cost of outsourcing = $5.75 per pound

Relevant cost of producing itself = Materials(Coffee)+Materials(packaging)+Labor+Variable OH+Fixed OH

= $3.00+$0.30+$1.00+$0.20+($3.00*30%)

= $3.00+$0.30+$1.00+$0.20+$0.90 = $5.40 per pound

As the cost of outsourcing of $5.75 per pound is more than cost of producing itself of $5.40 per pound, Central coffee co. should roast and package this product itself.

(Only 30% of the total fixed overhead is relevant for the decision because 30% of fixed overhead can be saved by accepting the offer).

b) The price at which Central coffee co. is indifferent about their decision to roast and package the product themselves or outsource will be equal to total relevant cost of roasting and packaging the product itself which is $5.40 per pound (as calculated in part a).

c) Total Fixed Overhead = 28,000 pounds*$3 per pound = $84,000

Saving in Fixed Overhead = $84,000*30% = $25,200

Saving in Fixed Overhead per unit = $25,200/20,000 pounds = $1.26

Relevant fixed overhead per unit will be equal to saving in fixed overhead per unit (i.e. $1.26 per pound)

Cost of outsourcing = $5.75 per pound

Relevant cost of producing itself = Materials(Coffee)+Materials(packaging)+Labor+Variable OH+Fixed OH

= $3.00+$0.30+$1.00+$0.20+$1.26 = $5.76 per pound

As the cost of outsourcing of $5.75 per pound is less than cost of producing itself of $5.76 per pound, Central coffee co. should outsource the production to the independent roaster.

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