Part 1: Make or Buy (Outsourcing)

V & T Faces, Inc., is a makeup company. They currently produce small plastic containers used to provide samples of the products. Management is interested in outsourcing the production of the plastic containers to a reputable manufacturing company that can supply the containers for $0.04 each. V & T Faces, Inc., incurs the following monthly production costs to produce 1,000,000 plastic containers internally:

	Per unit	Total monthly costs at 1,000,000 units
Variable production cost	0.02	20,000
Fixed production cost		25,000
Total production cost		45,000

If production is outsourced, all variable production costs and 70 percent of fixed production costs will be eliminated.

Required:

Perform differential analysis. Assume making the containers internally is Alternative 1 and buying the containers from an outside manufacturer is Alternative 2.

• Which alternative is best? Explain.
• Summarize the result of outsourcing production of the containers.
• Assume all the facts of this problem remain the same. However, management of V & T Faces, Inc., has an opportunity to lease the space it currently uses to produce containers for $4,000 per month if production of the containers is outsourced. Determine if V & T Faces, Inc., would be better off outsourcing production.
• Identify at least one qualitative factor that should be considered before management decides to outsource production of the containers.

Part 2: Product Line Decision

The following monthly segmented income statement is for V & T Faces, Inc.:

	Foundation	Blush	Eye shadow	Total
Sales Revenue	$20,000	$15,000	$23,000	$58,000
Variable Costs	11,000	8,000	9,000	28,000
Contribution Margin	9,000	7,000	14,000	30,000
Direct Fixed Costs	3,000	1,500	8,500	13,000
Allocated Fixed Costs	2,000	5,000	3,000	10,000
Profit	4,000	500	2,500	7,000

Management is concerned about the low profit associated with the blush product line and is considering dropping this product line. Allocated fixed costs are assigned to product lines based on shelf space used by each product line (measured in square feet), resulting in the following percentages for foundation, blush, and eye shadow, respectively: 20 percent, 50 percent, and 30 percent. If the blush product line is eliminated, total allocated fixed costs will be assigned as follows: 62.5 percent to foundation, and 37.5 percent to eye shadow. All variable and direct fixed costs for the blush product line will be eliminated.

Required:

Perform differential analysis. Assume keeping all product lines is Alternative 1 and dropping the blush product line is Alternative 2.

• Which alternative is best? Explain.
• Summarize the result of dropping the blush product.
• Assume the space available from dropping the blush product line can be used by the eye shadow product line, resulting in increased revenues for eye shadow of $12,000 and increased variable costs for eye shadow of $4,000. No additional direct fixed costs would be incurred, and 80 percent of allocated fixed costs would be assigned to eye shadow and 20 percent assigned to foundation.
  • Should the company drop the blush product line and use the freed-up space to expand the eye shadow product line? Alternative 1 assumes all product lines are kept and Alternative 2 assumes the blush product line is dropped with a corresponding expansion of the eye shadow product line.