Question

32. Make-or-Buy Decision and Qualitative Factors. Soda Bottling, Inc., currently bottles its own soda drinks. Management is interested in outsourcing the production of bottles to a reputable manufacturing company that can supply the bottles for $0.04 each. Soda Bottling incurs the following monthly production costs to produce 1,000,000 bottles internally. Total Monthly Cost at 1,000,000 Per Unit 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: 1. Perform differential analysis using the format presented in Figure 4.2 "Make-or-Buy Differential Analysis for Best Boards, Inc.". Assume making the product internally is Alternative 1, and buying the product from an outside manufacturer is Alternative 2. 2. Which alternative is best? Explain. 3. Summarize the result of outsourcing production using the format presented in Figure 4.3 "Summary of Differential Analysis for Best Boards, Inc.". 4. Assume all the facts of this problem remain the same. However, management of Soda Bottling has an opportunity to lease the space it currently uses to produce bottles for $6,000 per month if production of bottles is outsourced. Use the format presented in Figure 4.3 "Summary of Differential Analysis for Best Boards, Inc." to determine if Soda Bottling would be better off outsourcing production. (Hint: $6,000 will appear in the analysis as an opportunity cost similar to Figure 4.7 "Differential Analysis with Opportunity Cost for Barbeque Company".) 5. Identify at least one qualitative factor that should be considered before management decides to outsource production.Figure 4.2 Make-or-Buy Differential Analysis for Best Boards, Inc. Alternative 1 Alternative 2 (Make (Buy from Differential Internally) Outside) Amount Alternative 1 Is Variable costs Cost to buy from outside 00 $ 700,000 = $(700,000) Lower Direct materials 300,000 = 300,000 O Higher Direct labor 160,000 = 160,000 Higher Manufacturing overhead 100,000 O = 100,000 Higher Fixed costs Factory equipment lease 110,000 110,000 E OO Factory building rent 290,000 290,000 Production supervisors' salaries 140,000 90,000 = 50,000 Higher Total production costs $1, 100,000 $1, 190,000 = $ (90,000) LowerFigure 4.3 Summary of Differential Analysis for Best Boards, Inc. Result of Outsourcing Production of Wakeboards Cost increase to buy from outside $(700,000) Direct materials cost savings 300,000 Direct labor cost savings 160,000 Manufacturing overhead cost savings 100,000 Supervisor salaries cost savings 50,000 Cost increase from outsourcing $ (90,000 Note: Amounts shown in parentheses indicate a negative impact on profit, and amounts without parentheses indicate a positive impact on profit. The analysis shown in Figure 4.3 "Summary of Differential Analysis for Best Boards, Inc." is particularly useful if all costs are not easily identified, and differential costs can be determined. After all, the goal of differential analysis is to analyze the costs that differ from one alternative to the next. We often use the term avoidable cost to describe a cost that can be avoided, or eliminated, if one alternative is chosen over another. If Best Boards chooses to buy the product from an outside producer, the company avoids such costs as direct materials, direct labor, manufacturing overhead, and the salary of one supervisor. In this context, avoidable cost is the same as differential cost.Figure 4.7 Summary of Differential Analysis for Barbeque Company Result of Dropping Charcoal Barbecues Sales revenue lost $(90,000) Variable costs eliminated 40,000 Contribution margin eliminated $(50,000) Direct fixed costs eliminated 40,000 Loss from dropping product line $(10,000) Note: Amounts shown in parentheses indicate a negative impact on profit, and amounts without parentheses indicate a positive impact on profit. Figure 4.7 "Summary of Differential Analysis for Barbeque Company" shows that Barbeque Company will lose sales revenue of $90,000 if it drops the charcoal barbecues product line. However, it saves variable costs of $40,000 and direct fixed costs of $40,000 if it drops the charcoal barbecues product line. Because the $80,000 in cost savings is not enough to make up for the $90,000 loss in sales revenue, profit will decline by $10,000 (= $80,000 - $90,000)