Question B Make or buy analysis (15 marks)

Answer the questions below regarding a decision on whether to outsource the production of units where Company A does have full capacity utilization currently. Its current budget sales are $300,000,000 and operating profit is $75,000,000. The potential outsource supplier, Company B, has capacity to produce 250,000 units annually for Company A. Company As Board thinks it will be less costly to outsource. The Board believes the internal cost is $300 per unit while Company Bs cost is $280 all-in. So, outsourcing has to be less costly to Company A per the Board.

Questions

1. Calculate the additional operating profit accounting from outsourcing (i.e., stand-alone) 250,000 production units.
2. Calculate the return on sales currently and return on total sales if 250,000 units of production is outsourced.
3. Calculate the return on total sales if all excess production capacity is done internally.
4. Calculate the incremental per unit cost of outsourcing production compared to the internal per unit cost.
5. Justify whether you would make internally or outsource-buy production.

Production Capacity Units Excess Capacity Units 1,000,000 250,000 25.00% Unit Price Revenue 400 Selling Price - full capacity Selling Price - excess capacity 387,500,000 87,500,000 350 Unit Costs 100 80 Direct Materials Direct Labour Variable Factory Overhead Depreciation Service allocations 50 Excess Capacity 25,000,000 20,000,000 12,500,000 7,500,000 10,000,000 75,000,000 Full Capacity 100,000,000 80,000,000 50,000,000 30,000,000 40,000,000 300,000,000 30 40 300 Operting Profit - - Accounting 12,500,000 87,500,000 Outside cost for the units 280 if the work is outsourced