Morning Sky, Inc. (MSI), manufactures and sells computer games.The company has several product lines based on the age range of thetarget market. MSI sells both individual games as well as packagedsets. All games are in CD format, and some utilize accessories suchas steering wheels, electronic tablets, and hand controls. To date,MSI has developed and manufactured all the CDs itself as well asthe accessories and packaging for all of its products.
The gaming market has traditionally been targeted at teenagersand young adults; however, the increasing affordability ofcomputers and the incorporation of computer activities into juniorhigh and elementary school curriculums has led to a significantincrease in sales to younger children. MSI has always includedgames for younger children but now wants to expand its business tocapitalize on changes in the industry. The company currently hasexcess capacity and is investigating several possible ways toimprove profitability.
MSI is considering outsourcing the production of the handheldcontrol module used with some of its products. The company hasreceived a bid from Monte Legend Co. (MLC) to produce 25,000 unitsof the module per year for $22.00 each. The following informationpertains to MSI’s production of the controlmodules:
|
| Direct materials | $ | 13 |
| Direct labor | | 6 |
| Variable manufacturing overhead | | 2 |
| Fixed manufacturing overhead | | 8 |
| Total cost per unit | $ | 29 |
|
MSI has determined that it could eliminate all variable costs ifthe control modules were produced externally, but none of the fixedoverhead is avoidable. At this time, MSI has no specific use inmind for the space that is currently dedicated to the controlmodule production.
Required:
1. Compute the difference in cost between making andbuying the control module.
Difference in Cost:
2. Should MSI buy the modules from MLC or continueto make them?
3-a. Suppose that the MSI space currently used forthe modules could be utilized by a new product line that wouldgenerate $41,000 in annual profit. Recompute the difference in costbetween making and buying under this scenario.
Difference in Cost:
3-b. Does this change your recommendation toMSI?
