Outsourcing decision affected by equipment replacement During 2011, Vance Toy Company made 10,000 units of Model K, the costs of which follow.

An independent contractor has offered to make the same product for Vance for $50 each. Additional Information:
1. The manufacturing equipment originally cost $420,000 and has a book value of $240,000, a remaining useful life of four years, and a zero salvage value. If the equipment is not used to produce Model K in the production process, it can be leased for $40,000 per year.
2. Vance has the opportunity to purchase for $240,000 new manufacturing equipment that will have an expected useful life of four years and a salvage value of $80,000. This equipment will increase productivity substantially, thereby reducing unit-level labor costs by 20 percent.
3. If Vance discontinues the production of Model K, the company can eliminate 50 percent of its inventory holding cost.
Required
a. Determine the avoidable cost per unit to produce Model K assuming that Vance is considering the alternatives between making the product using the existing equipment and outsourcing the product to the independent contractor. Based on the quantitative data, should Vance outsource Model K? Support your answer with appropriate computations.
b. Assuming that Vance is considering whether to replace the old equipment with the new equipment, determine the avoidable cost per unit to produce Model K using the new equipment and the avoidable cost per unit to produce Model K using the old equipment. Calculate the impact on profitability if Model K were made using the old equipment versus the new equipment.
c. Assuming that Vance is considering either to purchase the new equipment or to outsource Model K, calculate the impact on profitability between the two alternatives.
d. Discuss the qualitative factors that Vance should consider before making a decision to outsource Model K. How can Vance minimize the risk of establishing a relationship with an unreliable supplier?

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Unit-level materials costs (10,000 units x $10) Unit-level labor costs (10,000 units x $40) Unit-level overhead costs (10,000 x $4) Depreciation on manufacturing equipment Model K production supervisor's salary Inventory holding costs Allocated portion of facility-level costs $100,000 400,000 40,000 60,000 60,000 120,000 80,000 $860,000 Total costs