Question

Outsourcing (Make-or-Buy) Decision
Mountain Air Limited manufactures a line of room air purifiers. Management is currently evaluating the possible production of an air purifier for automobiles. Based on an annual volume of 10,000 units, the predicted cost per unit of an auto air purifier follows.

Direct materials	$ 9.00
Direct labor	1.40
Factory overhead	10.00
Total	$ 20.40

These cost predictions include $80,000 in fixed factory overhead averaged over 10,000 units.

The completed air purifier units include a battery-operated electric motor, which Mountain Air assembles with parts purchased from an outside vendor for $2.00 per motor. Mini Motor Company has offered to supply an assembled battery-operated motor at a cost of $5.50 per unit, with a minimum annual order of 5,000 units. If Mountain Air accepts this offer, it will be able to reduce the variable labor and variable overhead costs of the auto air purifier by 50 percent.

(a) Determine whether Mountain Air should continue to make the electric motor or outsource it from Mini Motor Company.

• Calculate the net advantage (disadvantage) of outsourcing the electric motors from Mini Motor Company.

• Use a negative sign with your answer to indicate a net disadvantage (if applicable.)
  

(b) If it could otherwise rent the motor-assembly space for $25,000 per year, should it make or outsource this component?

• Calculate the net advantage (disadvantage) of outsourcing the motors, assuming the space could be rented.
• Use a negative sign with your answer to indicate a net disadvantage (if applicable).

(c) What additional factors should it consider in deciding whether to make or outsource the electric motors ? (choose from below)

-The quality of their own and the supplier's motors.

- The dependability of the supplier.

- Whether Mini Motor has a track record of meeting its commitments.

- Whether they can depend on Mini Motor to supply motors for a number of years or whether it is attempting to use some temporarily idle capacity.

- All of these.

Answer 1

(a)

Cost of the supply per unit from Mini Motor		$       5.50
Less: Savings in reducing
Cost of the part purchased from an outside vendor	$       2.00
Variable labor costs (by 50%)	$       0.70
Variable overhead (by 50%)	$       1.00
Total savings		$       3.70
Disadvantage per unit in buying from Mini Motor		$      -1.80
The total disadvantage for 10000 units		$ -18,000

Recommendation: The company should continue to make the electric motor because if purchased there will be a net disadvantage of ($18000) for 10000 units of air purifier.

Note:

Total overhead = 10000 x $10 = $100000

Fixed Overhead = $80000

Variable overhead = $100000 - $80000 = $20000

Variable overhead per unit = $20000 / 10000 units = $2 per unit

(b)

Net advantage = net disadvantage in buying the electric motors + income from renting the space = ($18000) + $25000 = $7000

It should outsource the electric motor

(c) All of these