1. A custom furniture manufacturer is considering outsourcing some of their oper
ID: 421334 • Letter: 1
Question
1. A custom furniture manufacturer is considering outsourcing some of their operation processes for a part. If they produce in-house, the process has a fixed cost of only $250,000 per year and variable costs of $250 per part. If the operation is outsourced, the variable cost will be $300 per part.
a. What is the break-even quantity beyond which the outsourcing becomes more attractive than the in-house production? (Show all calculations).
b. If the expected annual requirement for the parts is 7,500, which process should the manufacturer choose? Explain why.
Explanation / Answer
Given values:
In-house production:
Fixed cost = $250,000 per year
Variable cost = $250 per part
Outsourced production:
Variable cost = $300 per part
Solution:
(a) Suppose the total units produced = x units
Using the break-even analysis method, at x units, the total cost of both the production approaches will be equal. That is,
$250,000 + $250 x = $300 x
50 x = 250,000
x = 5,000 units
Break-even quantity = 5,000 units
If the number of units produced is less than 5,000 units, production should be outsourced.
If the number of units produced is greater than 5,000 units, production should be done in-house.
(b) Expected annual requirement = 7,500 units
From the above break-even analysis, for quantities greater than 5,000 units, production should be done in-house. Same can be validated through below calculations.
In-house production cost = $250,000 + $250 x
Outsourced production = $300 x
At x = 7,500
In-house production cost = $250,000 + ($250 x 7500) = $2,125,000
Outsourced production = ($300 x 7500) = $2,250,000
We can observe that for 7,500 units, the cost of outsourced production is greater than the cost of producing in-house. Therefore, production should be done in-house for 7,500 units.
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