Easylife Electrical Goods manufactures a range of washing machines, clothes dryers and dishwashers. One component is common

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Question:

Easylife Electrical Goods manufactures a range of washing machines, clothes dryers and dishwashers. One component is common to the product range; every product has the same electric motor which is manufactured in the Motor Division of Easylife. Ten thousand motors are produced annually.

These electric motors are transferred to the Assembly Division at full cost of production of $75, calculated as follows:

Direct materials $25

Direct labour: 2 hrs @ $15 30

Factory overhead 20

$75

The factory overhead is allocated using direct labour hours as the cost driver. Budgeted annual fixed overhead for the Motor Division amounts to $150 000, consisting of $100 000 incurred by the Motor Division plus $50 000 of general plant-wide fixed charges which are allocated to each division.

Management of Easylife have been approached by a salesman from the Hiroshima Electric Company. The salesman has offered to supply Hiroshima electric motors of equivalent performance for $72 each, in sufficient numbers to satisfy Easylife's requirements.

Required:

(a) Should Easylife continue to manufacture its own electric motors or purchase them from Hiroshima and hence close down the Motor Division? Explain.

(b) Suppose that Hiroshima make an alternative offer to sell the electric motors to Easylife for $65 each, but there would be no warranty on the motors. Consequently, in the event of a motor failure in the 12-month warranty period for its products, Easylife would have to purchase a replacement from Hiroshima at a reduced price of $50. Easylife estimates that 5% of motors purchased may fail during the warranty period.

Calculate the annual net advantage or disadvantage to Easylife from accepting this offer. State any qualitative factors which should be taken into account when considering such an offer.