Question

MSI is considering outsourcing the production of the handheid control module used with some of its products. The company has received a bid from Monte Legend Co. (MLC) to produce 18,000 units of the module per year for $25.00 each. The following information pertains to MSi's production of the control modules. Direct materials Direct labor Variable manufacturing overhead Fixed manufacturing overhead Total cost per unit $10 7 7 4 $28 MSI has determined that it could eliminate all variable costs if the control modules were produced externally, but none of the fixed overhead is avoidable. At this time, MSI has no specific use in mind for the space that is currently dedicated to the control module production. Required: 1. Compute the difference in cost between making and buying the control module. 2. Should MSI buy the modules from MLC or continue to make them? 3-a. Suppose that the MSI space currently used for the modules could be utilized by a new product line that would generate $28,000 in annual profit. Recompute the difference in cost between making and buying under this scenario. 3-b. Does this change your recommendation to MSI? Complete this question by entering your answers in the tabs below. Reg 1 Reg 2 Req 3A Req 3B Compute the difference in cost between making and buying the control module. Difference in Cost Ron2

Answer 1

Answer with explanation:

The Cost Volume Profit Analysis will help the management to take decision regarding making or buying the product.

1.

Units sold 18,000 units Direct materials Direct labor Variable manufacturing overhead Purchase cost Total Per unit Make Buy $10 $7 $7 $25 $24 $25 Total Cost Make Buy $180,000 $126,000 $126,000 $450,000 $432,000 $450,000

Difference in cost between making and buying the control module = Relevant Cost of making - Relevant Cost of buying = $432,000 - $450,000 = -$18,000

Cost of buying is $18,000 more than the cost of making 18,000 units of the control module.

2. MSI should continue to make the module.
(Because, the cost of making the module is less than the cost of buying the module. The cost of making the module is $24 per unit, but the cost of buying the module is $25 per unit.)

3.
a)

Total cost Opportunity cost Total relevant cost Make Buy $432,000 $450,000 $28,000 $460,000 $450,000

(Fixed manufacturing overhead cost does not consider for buy or make decisions because such costs do not change as a result of the decision to make or buy the product.)

Opportunity cost of new product line = $28,000

Difference in cost between making and buying = Relevant Cost of making - Relevant Cost of buying = $460,000 - $450,000 = $10,000

b) Yes. Now the recommendation changed to Buy the MSI. The relevant cost of making is now more than the relevant cost of buying.