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 9,000 units per year for $8.00 each. Mohave has the following information about the cost of producing tote bags:
Direct materials $5.00
Direct labor 1.00
Variable manufacturing overhead 1.00
Fixed manufacturing overhead 2.00
Total cost per unit $9.00

Mohave has determined that all variable costs could be eliminated by outsourcing the tote bags, while 70 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:
a. Compute the difference in cost between making and buying the umbrella tote bag.
b. Based strictly on the incremental analysis, should Mohave buy the tote bags or continue to make them?

Answer 1

Answer:

Please see below

Explanation:

1. The level of production for the subject analysis is 9,000 units per year

Options for outsourcing

Variable unit costs = $8.00

Unavoidable unit fixed costs = 70% × $2 = $1.4

Total : $8 + $1.4 = $9.4 per unit

In house option:

Direct materials = $5

Direct labor = $1

Variable manufacturing overhead = $1

Fixed manufacturing overhead = $2

Total : $9

The cost of buying the umbrella outside is $9.4 , which is $0.4 higher than making it in-company.

2. Mohave should continue to make the tote bags instead of buying them.