Thomas Manufacturing must decide whether to insource or outsource a new toxic-fr

Question

Thomas Manufacturing must decide whether to insource or outsource a new toxic-free carpet cleaner that works with its Heaven Carpet Cleaning Machine. If it decides to insource the product, the process would incur $300,000 of annual fixed costs and $1.50 per unit of variable costs. If it is outsourced, a supplier has offered to make it for an annual fixed cost of $120,000 and a variable cost of $2.25 per unit in variable costs

1) Given these two alternatives, determine the indifference point (where costs are equal)

2) If the expected demand for the new miracle cleaner is 300,000 units, what would you recommend that Thomas Manufacturing do?

Explanation / Answer

For insourcing

For outsourcing

1)Indifference point is the point at which the total cost for both the alternatives are equal

Let the demand of the cleaner = Q

Total cost for in sourcing = Total cost of outsourcing

=> FC + (Q X VC) = FC + (Q X VC)

=> 300000 + (Q X 1.50) = 120000 + (Q X 2.25)

=> 300000 + 1.50Q = 120000 + 2.25Q

=> 2.25Q - 1.50Q = 300000-120000

=> 0.75Q = 180000

=> Q = 180000/0.75

=> Q = 240000

So the indifference point is 240000 cleaners

2) If the expected demand(Q) = 300000

Total cost for in sourcing = FC + (Q x VC) = 300000 + (300000x1.50) = 300000+450000 = $750000

Total cost for outsourcing = FC +(Q x VC) = 120000+(300000x2.25) = 120000+675000 = $795000

So thomas manufacturing should insource as it has a lower total cost than outsourcing

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