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 8,300 units per year for $10.00 each. Mohave has the following information about the cost of producing tote bags:

Direct materials	$	6.00
Direct labor		2.00
Variable manufacturing overhead		1.00
Fixed manufacturing overhead		1.50
Total cost per unit	$	10.50

Mohave has determined that all variable costs could be eliminated by outsourcing the tote bags, while 60 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:
1. Compute the difference in cost between making and buying the umbrella tote bag.
2. Based strictly on the incremental analysis, should Mohave buy the tote bags or continue to make them?
3-a. Suppose that the space Mohave currently uses to make the bags could be utilized by a new product line that would generate $10,000 in annual profits. Recompute the difference in cost between making and buying the umbrella tote bag.
3-b. Does this change your recommendation to Mohave?

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Answer 1

1) Differential cost :

	make	Buy
Direct material	49800
Direct labor	16600
Variable overhead	8300
Fixed overhead (8300*1.5*40%)	4980
Purchase cost		83000
Total	79680	83000

Differential cost = 79680-83000 = 3320

2) Make

3a) Differential cost :

	make	Buy
Direct material	49800
Direct labor	16600
Variable overhead	8300
Fixed overhead (8300*1.5*40%)	4980
Opportunity cost	10000
Purchase cost		83000
Total	89680	83000

Differential cost = 89680-83000 = 6680

3b) Buy