Mohave Corp. is considering outsourcing production of the umbrella tote bag included with some of its products. The company has received a bid from Willow Co. to produce
8,000 units per year for $7.50 each. Mohave has the following information about its own production of the tote bags:
Direct materials ............ $3
Direct labor .............. 2
Variable manufacturing overhead ..... 1
Fixed manufacturing overhead ..... 2
Total cost per unit ........... $8
Mohave has determined that all variable costs could be eliminated by dropping production of the tote bags, while 60 percent of the fixed overhead cost is unavoidable. At this time, Mohave has no specific use in mind for the space currently dedicated to producing the tote bags.
1. Compute the difference in cost between making and buying the umbrella tote bag.
2. Should Mohave buy the tote bags from Willow or continue to make them?
3. Suppose that the space Mohave currently uses to make the bags could be utilized by a new product line that would generate $10,000 in annual profits. Re-compute the difference in cost between making and buying the umbrella tote bag. Does this change your recommendation to Mohave? If so, how?