ABC Engineering manufactures small engines. The engines are sold to manufacturers who install them in products such as lawnmowers. The company currently manufactures all the parts used in these engines but is considering a proposal from a reliable external supplier, Vaughan Technological, who has offered to supply a starter assembly used in these engines.

Direct materials: $175,000

Direct labour: $125,000

Manufacturing overhead: $350,000

Total: $$650,000

The starter assembly is currently manufactured in Division 8 of ABC Engineering. The costs relating to Division 8 for the past 12 months were as follows:

Over the past year, Division 8 manufactured 165,000 starter assemblies. Therefore, the average cost of a starter assembly is computed as $3.94 ($650,000 165,000).

Further analysis of manufacturing overhead revealed the following information:

Of the total manufacturing overhead reported, 20% is variable. Of the fixed portion, $140,000 is an allocation of general factory overhead that would remain unchanged for the company as a whole if production of the starter assembly is discontinued. A further $60,000 of the manufacturing overhead is avoidable if the manufacture of the starter assembly is discontinued. The balance of the fixed overhead, $80,000, is the division manager's salary. If the manufacture of the starter assembly is discontinued, the manager of Division 8 would be transferred to Division 2 at the same salary. The move would allow the company to save the $65,000 that would otherwise be paid to attract an outsider to this position.

Required for homework:

a) Vaughan Technological has offered to supply starter assemblies at $3.50 per unit. Since this is less than the current average cost of $3.94 per unit, the vice-president of manufacturing is eager to accept this offer. Should the outside offer be accepted? Provide an analysis of all relevant costs in your answer.

b) How, if at all, would your response to part a) change if the company could use the vacated plant space for storage and, in so doing, avoid $40,000 of outside storage charges currently incurred? Why is this information relevant or irrelevant?

c) At what level of production will the make-versus-buy costs be equal?

d) What are some of the qualitative factors the manager needs to consider with the relevant cost analysis?