One of Riku Company's major products is a fuel additive designed to improve fuel efficiency and keep engines clean. Riku, a petrochemical firm, makes and sells 100,000 units of the fuel additive per year. Its management is evaluating the possibility of having an outside supplier manufacture the product for Riku for $3.20 each. Riku would continue to sell and distribute the fuel additive under its own brand name for either alternative. Riku's accountant constructed the following profitability analysis:
Revenue (100,000 units × $6.00).........................................$600,000
Unit-level materials costs (100,000 units × $1.20).....................(120,000)
Unit-level labor costs (100,000 units × $0.20) ..........................(20,000)
Unit-level overhead costs (100,000 × $0.50) ............................(50,000)
Unit-level selling expenses (100,000 × $0.20) ..........................(20,000)
Contribution margin..........................................................390,000
Fuel additive production supervisor's salary...........................(160,000)
Allocated portion of facility-level costs..................................(50,000)
Product-level advertising cost..............................................(80,000)
Contribution to companywide income..................................$100,000
Required
a. Identify the cost items relevant to the make-or-outsource decision.
b. Should Riku continue to make the fuel additive or buy it from the supplier? Support your answer by determining the change in net income if Riku buys the fuel additive instead of making it.
c. Suppose that Riku is able to increase sales by 60,000 units (sales will increase to 160,000 units). At this level of sales, should Riku make or buy the fuel additive? Support your answer by explaining how the increase in production affects the cost per unit.
d. Discuss the qualitative factors that Riku should consider before deciding to outsource the fuel additive. How can Riku minimize the risk of establishing a relationship with an unreliable supplier?