During 2018, Adaire Toy Company made 10,000 units of Model K, the costs of which follow:
Unit-level materials costs (10,000 units × $30).......$ 300,000
Unit-level labor costs (10,000 units × $40)...............400,000
Unit-level overhead costs (10,000 × $8).....................80,000
Depreciation on manufacturing equipment...............120,000
Model K production supervisor's salary..................120,000
Inventory holding costs.......................................240,000
Allocated portion of facility-level costs...................160,000
Total costs.................................................$1,420,000
An independent contractor has offered to make the same product for Adaire for $70 each.
Additional Information:
1. The manufacturing equipment originally cost $840,000 and has a book value of $480,000, a remaining useful life of four years, and a zero salvage value. If the equipment is not used to produce Model K in the production process, it can be leased for $80,000 per year.
2. Adaire has the opportunity to purchase for $480,000 new manufacturing equipment that will have an expected useful life of four years and a salvage value of $160,000. This equipment will increase productivity substantially, thereby reducing unit-level labor costs by 20 percent.
3. If Adaire discontinues the production of Model K, the company can eliminate 50 percent of its inventory holding cost.
Required
a. Determine the avoidable cost per unit to produce Model K assuming that Adaire is considering the alternatives between making the product using the existing equipment and outsourcing the product to the independent contractor. Based on the quantitative data, should Adaire outsource Model K? Support your answer with appropriate computations.
b. Assuming that Adaire is considering whether to replace the old equipment with the new equipment, determine the avoidable cost per unit to produce Model K using the new equipment and the avoidable cost per unit to produce Model K using the old equipment. Calculate the impact on profitability if Model K were made using the old equipment versus the new equipment.
c. Assuming that Adaire is considering either to purchase the new equipment or to outsource Model K, calculate the impact on profitability between the two alternatives.
d. Discuss the qualitative factors that Adaire should consider before making a decision to outsource Model K. How can Adaire minimize the risk of establishing a relationship with an unreliable supplier?