Question

Mohave Corp. is considering outsourcing production of the umbrella tote bag included with some of its products. The company has received a bid from a supplier in Vietnam to produce 8,000 units per year for $7.50 each. Mohave has the following information about the cost of producing tote bags:
Direct materials $3
Direct labor 2
Variable manufacturing overhead 1
Fixed manufacturing overhead 2
Total cost per unit $8
Mohave has determined that all variable costs could be eliminated by outsourcing the tote bags, while 60 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.
2. Based strictly on the incremental analysis, should Mohave buy the tote bags or continue to make them?
3. Suppose that the space Mohave currently uses to make the bags could be utilized by a new product line that would generate $10,000 in annual profits. Recompute the difference in cost between making and buying the umbrella tote bag. Does this change your recommendation to Mohave? If so, how?
4. Assume Mohave has a sustainability goal to increase the percentage of spending from local suppliers. If Mohave’s managers are responsible for improving this metric, how might it impact their sourcing decisions?
5. What other strategic or sustainability-related goals should Mohave consider before making a final decision?

Answer 1

Answer:

Mohave Corp.

1. Cost Differences:

Relevant costs:

                                                     Make             Buy        Difference

Direct materials                              $3

Direct labor                                       2

Variable manufacturing overhead   1

Fixed manufacturing overhead       0.80

Total cost per unit                          $6.80        $7.50          $0.70

Annual Units                                  8,000        8,000          8,000

Total costs                                 $54,400   $60,000       $5,600

2. Based strictly on the incremental analysis, Mohave should continue to make the tote bags.

3. The recommendation is changed.  Mohave should buy the tote bags from outside.  Buying from outside increases operating income by $4,400.

Explanation:

a) Data and Calculations:

Price per unit from outside supplier = $7.50

Direct materials                             $3

Direct labor                                      2

Variable manufacturing overhead 1

Fixed manufacturing overhead     2

Total cost per unit                        $8

Relevant costs:

                                                     Make             Buy        Difference

Direct materials                              $3

Direct labor                                       2

Variable manufacturing overhead   1

Fixed manufacturing overhead       0.80

Total cost per unit                          $6.80        $7.50          $0.70

Annual Units                                  8,000        8,000          8,000

Total costs                                 $54,400   $60,000       $5,600

Relevant costs:

                                                     Make             Buy        Difference

Direct materials                              $3

Direct labor                                       2

Variable manufacturing overhead   1

Fixed manufacturing overhead       0.80

Total cost per unit                          $6.80        $7.50          $0.70

Annual Units                                  8,000        8,000          8,000

Total costs                                 $54,400   $60,000       $5,600

Annual profits from new product        0     (10,000)     $10,000

Total net costs                          $54,400   $50,000       $4,400