11-40 Make or buy, unknown level ofvolume. (A. Atkinson, adapted) Denver Engineering manufac-tures small engines that it sells to manufacturers who install themin products such as lawn mowers. The company currently manufacturesall the parts used in these engines but is considering a proposalfrom an external supplier who wishes to supply the starterassemblies used in these engines.

The starter assemblies are currently manufactured in Division 3of Denver Engineering. The costs relat- ing to the starterassemblies for the past 12 months were as follows:

Directmaterials                                                  $550,000
Variable direct manufacturing labor $300,000

Manufacturing overhead $800,000
Total $1,650,000

Over the past year, Division 3 manufactured 150,000 starterassemblies. The average cost for each starter assembly is $10($1,500,000 / 150,000).

Further analysis of manufacturing overhead revealed thefollowing information. Of the total manufac- turing overhead, only25% is considered variable. Of the fixed portion, $300,000 is anallocation of general overhead that will remain unchanged for thecompany as a whole if production of the starter assemblies isdiscontinued. A further $200,000 of the fixed overhead is avoidableif production of the starter assemblies is discontinued. Thebalance of the current fixed overhead, $100,000, is the divisionmanager’s salary. If Denver Engineering discontinues production ofthe starter assemblies, the manager of Division 3 will betransferred to Division 2 at the same salary. This move will allowthe company to save the $80,000 salary that would otherwise be paidto attract an outsider to this position.

1. Tutwiler Electronics, a reliable supplier, has offeredto supply starter-assembly units at $8 per unit. Because this priceis less than the current average cost of $10 per unit, the vicepresident of manufacturing is eager to accept this offer. On thebasis of financial considerations alone, should Denver Engineeringaccept the outside offer? Show your calculations. (Hint:Production output in the coming year may be different fromproduction output in the past year.)
2. How, if at all, would your response to requirement 1change if the company could use the vacated plant space for storageand, in so doing, avoid $100,000 of outside storage chargescurrently incurred? Why is this information relevant orirrelevant?