Fibre Systems manufactures an optical switch that it uses in its final product. Fibre Systems incurred the following manufacturing costs when it produced 70,000 units last year:
Direct materials.................................................................................. $ 630,000
Direct labour...................................................................................... 105,000
Variable overhead.............................................................................. 140,000
Fixed overhead................................................................................... 455,000
Total manufacturing cost for 70,000 units......................................... $1,330,000
Fibre Systems does not yet know how many switches it will need this year; however, another company has offered to sell Fibre Systems the switch for $14 per unit. If Fibre Systems buys the switch from the outside supplier, the manufacturing facilities that become idle cannot be used for any other purpose, yet none of the fixed costs are avoidable.
Requirements
1. Given the same cost structure, should Fibre Systems make or buy the switch? Show your analysis.
2. Now, assume that Fibre Systems can avoid $100,000 of fixed costs a year by outsourcing production. In addition, because sales are increasing, Fibre Systems needs 75,000 switches a year rather than 70,000. What should Fibre Systems do now?
3. Given the last scenario, what is the most Fibre Systems would be willing to pay to outsource the switches?