SM manufactures small engines that it sells to manufacturers whoinstall them in products such as lawn mowers. The company currentlymanufactures all the parts used in these engines but is consideringa proposal from an external supplier who wishes to supply thestarter assemblies used in these engines.
The starter assemblies are currently manufactured in Division 3of SM. The costs relating to the starter assemblies for the past 12months were as follows:
Direct materials | $400,000 |
Manufacturing labour | 300,000 |
Manufacturing overhead | 800,000 |
Total | $1,500,000 |
Over the past year, Division 3 manufactured 150,000 starterassemblies.
Further analysis of manufacturing overhead revealed thefollowing information:
Of the total manufacturing overhead, only 25% is consideredvariable. Of the fixed portion, $300,000 is an allocation ofgeneral overhead that will remain unchanged for the company as awhole if production of the starter assemblies is discontinued. Afurther $200,000 of the fixed overhead is avoidable if productionof the starter assemblies is discontinued. The balance of thecurrent fixed overhead, $100,000, is the division manager’s salary.If SM discontinues production of the starter assemblies, themanager of Division 3 will be transferred to Division 2 at the samesalary. This move will allow the company to save the $80,000 salarythat would otherwise be paid to attract an outsider to thisposition.
Required
- Good Supply, a reliable supplier, has offered to supplystarter-assembly units at $8 per unit. Because this price is lessthan the current average cost per unit, the vice president ofmanufacturing is eager to accept this offer. On the basis offinancial considerations alone, should SM accept the outside offerassuming that production remains consistent with the past year?Show your calculations.
- How, if at all, would your response to requirement 1 change ifthe company could use the vacated plant space for storage and, inso doing, avoid $100,000 of outside storage charges currentlyincurred? Why is this information relevant or irrelevant?
- Assume that demand increases and SM requires 190,000 units. Onthe basis of financial considerations alone, should SM accept theoutside offer? Show your calculations.
