World Systems manufactures an optical switch that it uses in its final product. World Systems incurred the following manufacturing costs when it produced 66,000 units last year:
Direct materials . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . $ 726,000
Direct labor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99,000
Variable overhead . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. .. . . . . . . 132,000
Fixed overhead . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. .. . . . 363,000
Total manufacturing cost for 66,000 units . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. $1,320,000
World Systems does not yet know how many switches it will need this year; however, another company has offered to sell World Systems the switch for $12.50 per unit. If World Systems buys the switch from the outside supplier, the manufacturing facilities that will be idle cannot be used for any other purpose, yet none of the fixed costs are avoidable.
Requirements
1. Given the same cost structure, should World Systems make or buy the switch? Show your analysis.
2. Now, assume that World Systems can avoid $99,000 of fixed costs a year by outsourcing production. In addition, because sales are increasing, World Systems needs 71,000 switches a year rather than 66,000. What should World Systems do now?
3. Given the last scenario, what is the most World Systems would be willing to pay to outsource the switches?