Question

After graduating from Yorkville University with a BBA, you are offered a job at Bombardeer Inc. which makes engines. You were hired directly out of school as you have a very good reputation as an honest and ethical student. You never plagiarize or cheat on exams and set a good example for other students with your strong work ethic.

Currently, Bombardeer manufactures all parts used in these engines (including starter assemblies). Your friend Sukhdeep, who also went to Yorkville University, (he did not graduate as he rarely attended classes, and had been written up for academic misconduct on several occasions),works as a sales representative at Trident Inc. and has proposed to sell your company starter assemblies that are used in Bombardeer’s engines.

The starter assemblies are currently manufactured in Plant 7 of Bombardeer Inc. The costs relating to the starter assemblies were as follows:

Direct materials                                               700,000

Variable direct manufacturing labour             600,000

Manufacturing overhead                                 900,000

Total                                                                2,200,000

Plant7 manufactured 176,000 starter assemblies. The average cost for each starter assembly is $12.50.

You conduct further analysis and discover that 38% of manufacturing overhead is variable.Of the fixed portion, $300,000 is an allocation of general overhead that will remain unchanged for the company as a whole if production of the starter assemblies is discontinued.A further $250,000 of the fixed overhead is avoidable if production of the starter assemblies is discontinued. The balance of the current fixed overhead, $100,000, is the division manager’s salary.If Bombardeer discontinues production of the starter assemblies, the manager of Plant 7 will be transferred to Plant 2 at the same salary. This move will allow the company to save the $70,000 salary that would otherwise be paid to attract an outsider to this position.

You just found out that your friend Sukhdeep had been fired from his current job at Trident Inc. as he had continued to behave in an inappropriate manner. He would not show up to work and often mislead his customers (as he did his teachers at Yorkville). This conductwas not tolerated at Trident Inc., as this is a very reputable company

Required

1. Trident Inc, a reliable supplier, has offered to supply starter-assembly units at $10 per unit. Because this price is less than the current average cost of $12.50 per unit, the vice president of manufacturing is eager to accept this offer. On the basis of financial considerations alone, should Bombardeer accept the outside offer? Show your calculations.

2. How, if at all, would your response to requirement 1 change if the company could use the vacated plant space for storage and, in so doing, avoid $150,000 of outside storage charges currently incurred? Why is this information relevant or irrelevant?

Answer 1

1 Evaluation of Make vs. Buy Make Buy Direct Material Direct Labor Variable manufacturing overheads Avoidable overheads Purchase cost ( 176,000*$10) Total relevant costs $700,000 $600,000 $342,000 $250,000 $1,760,000 $1,892,000 $1,760,000 Differential Impact $700,000 $600,000 $342,000 $250,000 -$1,760,000 $132,000 Conclusion The component should be purchased externally since the cost to purchase is lower 2 Make $1,892,000 Total relevant costs Opportunity cost Total relevant costs Buy $1,760,000 -$150,000 $1,610,000 Differential Impact $132,000 $150,000 $282,000 $1,892,000 The cost to buy is lower than cost to make The information is relevant since it is the opportunity cost of buying the component from external supplier The opportunity cost increases cost of making or reduces cost of buying