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Make-or-Buy Decision. Ocean Products, Inc., currently manufactures its own surfboards for customers. Management is interested in outsourcing the production of these surfboards to a reputable manufacturing company that can supply the surfboards for $80 per unit. Ocean Products, Inc., incurs the following annual production costs to produce 10,000 surfboards internally.

If production is outsourced, all variable production costs, factory building and equipment lease costs, and factory insurance costs will be eliminated. The production supervisors salary cost will remain regardless of the decision to outsource or to produce internally because the supervisor recently signed a long-term contract with Ocean Products, Inc.

Required:

1. Perform differential analysis using the format presented in Figure 7.2. Assume making the surfboards internally is Alternative 1, and buying the surfboards from an outside manufacturer is Alternative 2. Figure 7.2

2. Which alternative is best? Explain.

3. Summarize the result of outsourcing production using the format presented in Figure 7.3.Figure 7.3

4. Compare the format used in requirement a with that of requirement c.

Total Annual Cost at 10,000 Units Per Unit $20 10 30 $200,000 100,000 300,000 Variable production costs Direct materials Direct labor Manufacturing overhead Fixed production costs Factory building and equipment lease Factory insurance Production supervisor's salary Total production costs 70,000 50,000 100,000 $820,000 Alternative 1 (Make Internally) Alternative 2 (Buy from Outside) Differential Amount Alternative 1 Is $ $ 700,000 0 0 300,000 160,000 100,000 i !! 11 $(700,000) 300,000 160,000 100,000 Variable costs Cost to buy from outside Direct materials Direct labor Manufacturing overhead Fixed costs Factory equipment lease Factory building rent Production supervisors'salaries Total production costs Lower Higher Higher Higher 0 ll 110,000 290,000 140,000 $1,100,000 110,000 290,000 90,000 = $1,190,000 0 0 50,000 $ (90,000) Higher Lower Result of Outsourcing Production of Wakeboards Cost increase to buy from outside Direct materials cost savings Direct labor cost savings Manufacturing overhead cost savings Supervisor salaries cost savings Cost increase from outsourcing $(700,000) 300,000 160,000 100,000 50,000 $ (90,000)