Oxford Engineering manufactures small engines. The engines are sold to manufacturers who install them in such products as lawn mowers. The company currently manufactures all the parts used in these engines but is considering a proposal from an external supplier who wants to supply the starter assembly used in these engines. The starter assembly is currently manufactured in Division 3 of Oxford Engineering. The costs relating to Division 3 for the past 12 months were as follows:
Direct materials ............... $220,000
Direct manufacturing labour .......... 165,000
Manufacturing overhead .......... 440,000
Total ................... $825,000
Over the past year, Division 3 manufactured 150,000 starter assemblies; the average cost for the starter assembly is computed as $5.50 ($825,000 × 150,000).Further analysis of manufacturing overhead revealed the following information. Of the total manufacturing overhead reported, only 25% is considered variable. Of the fixed portion, $150,000 is an allocation of general overhead that would remain unchanged for the company as a whole if production of the starter assembly is discontinued. A further $100,000 of the fixed overhead is avoidable if self-manufacture of the starter assembly is discontinued. The balance of the current fixed overhead, $80,000, is the division manager’s salary. If self-manufacture of the starter assembly is discontinued, the manager of Division 3 will be transferred to Division 2at the same salary. This move will allow the company to save the $40,000 salary that would otherwise be paid to attract an outsider to this position.
REQUIRED
1. Tidnish Electronics, a reliable supplier, has offered to supply starter assembly units at $4 per unit. Since this price is less than the current average cost of $5.50 per unit, the vice-president of manufacturing is eager to accept this offer. Should the outside offer be accepted?
2. How, if at all, would your response to requirement 1 change if the company could use the vacated plant space for storage and, in so doing, avoid $50,000 of outside storage charges currently incurred? Why is this information relevant or irrelevant?