Effects of the level of production on an outsourcing decision
Seymour Chemical Company makes a variety of cosmetic products, one of which is a skin cream designed to reduce the signs of aging. Seymour produces a relatively small amount (15,000 units) of the cream and is considering the purchase of the product from an outside supplier for $4.50 each. If Seymour purchases from the outside supplier, it would continue to sell and distribute the cream under its own brand name. Seymour’s accountant constructed the following profitability analysis.
Revenue (15,000 units × $10) | $150,000 |
Unit-level materials costs (15,000 units × $1.40) | (21,000) |
Unit-level labor costs (15,000 units × $0.50) | (7,500) |
Unit-level overhead costs (15,000 × $0.10) | (1,500) |
Unit-level selling expenses (15,000 × $0.20) | (3,000) |
Contribution margin | 117,000 |
Skin cream production supervisor’s salary | (44,000) |
Allocated portion of facility-level costs | (11,300) |
Product-level advertising cost | (34,000) |
Contribution to companywide income | $ 27,700 |
Required
a.Identify the cost items relevant to the make-or-outsource decision.
b. Should Seymour continue to make the product or buy it from the supplier? Support your answer by determining the change in net income if Seymour buys the cream instead of making it.
c. Suppose that Seymour is able to increase sales by 10,000 units (sales will increase to 25,000 units). At this level of production, should Seymour make or buy the cream? Support your answer by explaining how the increase in production affects the cost per unit.
d. Discuss the qualitative factors that Seymour should consider before deciding to outsource the skin cream. How can Seymour minimize the risk of establishing a relationship with an unreliable supplier?
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