Question

The Svenson Corporation manufactures cellular modems. It manufactures its own cellular modem circuit boards​ (CMCB), an important part of the cellular modem. It reports the following cost information about the costs of making CMCBs in 2017 and the expected costs in 2018​:

Current Costs ...........................................................................................2017 ..................................Expected Costs in in 2018

Variable manufacturing costs

* Direct material cost per CMCB.................. ...............................................180 ......................................... $170

* Direct manufacturing labour cost per CMCB............................................... 50............................................... 45

* Variable manufacturing cost per batch for setups, material.........................1,600 .....................................1,500

handling, and quality control

* Fixed manufacturing cost

* Fixed manufacturing overhead costs ............................................................320000 .............................320000

that can be avoided if CMCBs

are not made

* Fixed manufacturing overhead costs of plant depreciation,..................................... 800000 ...............800000

insurance, and administration that cannot be avoided even if

CMCBs are not made

Make-versus-buy information

Svenson manufactured 8,000 CMCBs in 2017 in 40 batches of 200 each. In 2018​, Svenson anticipates needing 10,000 CMCBs. The CMCBs would be produced in 80 batches of 125 each. The Minton Corporation has approached Svenson about supplying CMCBs to Svenson in 2018 at $300 per CMCB on whatever delivery schedule Svenson wants.

Requirement 3. Now suppose that if Svenson purchases CMCBs from Minton​, its best alternative use of the capacity currently used for CMCBs is to make and sell special circuit boards​ (CB3s) to the Essex Corporation. Svenson estimates incremental revenues from selling CB3s to be $2,000,000​, and incremental costs from making CB3s to be $2,150,000. On the basis of financial considerations​ alone, should Svenson make CMCBs or buy them from Minton​?

Show your calculations. ​(Complete all answer boxes. For amounts with a​ $0 balance, make sure to enter​ "0" in the appropriate​ cell.)

	Choices for Svenson
	Make CMCBs	Buy CMCBs	Buy CMCBs
	and Do Not	and Do Not	and Make
Relevant Items	Make CB3s	Make CB3s	CB3s
Total incremental costs of	?	?	?
making/buying CMCBs (from	?	?	?
requirement 2)
Excess of future costs over future
revenues from CB3s
Total relevant costs	?	?	?

I am sorry this is not very organized, please help with requirement 3. Thank you

Requirement 1. Calculate the total expected manufacturing cost per unit of making CMCBs in

2018.

	Total Manufacturing	Manufacturing
	Costs of CMCB	Cost per Unit
Direct materials	$1,700,000	$170
Direct manufacturing labour	450,000	45
Variable batch manufacturing costs	120,000	12
Fixed manufacturing costs
Avoidable fixed manufacturing costs	320,000	32
Unavoidable fixed manufacturing costs	800,000	80
Total manufacturing costs	$3,390,000	$339

Requirement 2. Suppose the capacity currently used to make CMCBs will become idle if Svenson purchases CMCBs from Minton. On the basis of financial considerations​ alone, should Svenson make CMCBs or buy them from Minton​? Show your calculations. ​(If a box is not used in the​ table, leave the box​ empty; do not enter a​ zero.)

	Make		Buy
	Total	Per Unit	Total	Per Unit
Direct materials	$1,700,000	$170
Direct manufacturing labour	450,000	45
Variable batch manufacturing costs	120,000	12
Avoidable fixed manufacturing costs	320,000	32
Purchase cost			3,000,000	300.000
Total relevant costs	$2,590,000	$259	$3,000,000	$300

Svenson should make CMCBs because it costs less to make than to buy.

Answer 1

1. The expected manufacturing cost per unit of CMCBs in 2018 is as follows:

Total Manufacturing Manufacturing Costs of CMCB Cost per Unit (2) = (1) - 10,000 $1,700,000 $170 450.000 45 120,000 12 (1) Direct materials, $170 x 10,000 Direct manufacturing labor, $45 x 10,000 Variable batch manufacturing costs $1.500 x 80 Fixed manufacturing costs Avoidable fixed manufacturing costs Unavoidable fixed manufacturing costs Total manufacturing costs 32 320.000 800,000 $3.390.000 80 $339

2. The following table identifies the incremental costs in 2015 if Svenson (a) made CMCBs and (b) purchased CMCBs from Minton.

Total Per-Unit Incremental Costs Incremental Costs Make Buy $300 $170 Incremental Items Cost of purchasing CMCBs from Minton Direct materials Direct manufacturing labor Variable batch manufacturing costs Avoidable fixed manufacturing costs Total incremental costs Make Buy $3,000,000 $1,700.000 450,000 120,000 320,000 $2.590.000 $3.000.000 45 12 32 $259 $300 † 1 î Difference in favor of making $410,000 $41

The opportunity cost of using capacity to make CMCBs is zero because Svenson would keep this capacity idle if it purchases CMCBs from Minton.  

Svenson should continue to manufacture the CMCBs internally because the incremental costs to manufacture are $259 per unit compared to the $300 per unit that Minton has quoted.  Note that the unavoidable fixed manufacturing costs of $800,000 ($80 per unit) will continue to be incurred whether Svenson makes or buys CMCBs. These are not incremental costs under either the make or the buy alternative and, hence, are irrelevant.

3. Svenson should continue to make CMCBs. The simplest way to analyze this problem is to recognize that Svenson would prefer to keep any excess capacity idle rather than use it to make CB3s. Why? Because expected incremental future revenues from CB3s, $2,000,000, are less than expected incremental future costs, $2,150,000. If Svenson keeps its capacity idle, we know from requirement 2 that it should make CMCBs rather than buy them.

An important point to note is that, because Svenson forgoes no contribution by not being able to make and sell CB3s, the opportunity cost of using its facilities to make CMCBs is zero.  It is, therefore, not forgoing any profits by using the capacity to manufacture CMCBs.  If it does not manufacture CMCBs, rather than lose money on CB3s, Svenson will keep capacity idle.

A longer and more detailed approach is to use the total alternatives or opportunity cost analyses shown in Exhibit 11-7 of the chapter.

Svenson will minimize manufacturing costs and maximize operating income by making CMCBs.

Choices for Svenson Make CMCBS Buy CMCBs and Do Not and Make Relevant Items Make CB3s CB3s, if Profitable TOTAL-ALTERNATIVES APPROACH TO MAKE-OR-BUY DECISIONS $2.590.000 $3,000,000 Total incremental costs of making/buying CMCBs (from requirement 2) Because incremental future costs exceed incremental future revenues from CB3s, Svenson will make zero CB3s even if it buys CMCBs from Minton 0 0 Total relevant costs $2.590.000 $3.000.000

OPPORTUNITY-COST APPROACH TO MAKE-OR-BUY DECISIONS

$2,590,000 $3,000,000 Total incremental costs of making buying CMCBs (from requirement 2) Opportunity cost: profit contribution forgone because capacity will not be used to make CB3s 09 0 $3.000.000 Total relevant costs $2.590.000

*Opportunity cost is zero because Svenson does not give up anything by not making CB3s. Svenson is best off leaving the capacity idle (rather thanmanufacturing and selling CB3s).