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 to supply the starter assembly used in these engines. The starter assembly is currently manufactured in Division 3 of Oxford Engineering. Last year, Division 3 manufactured 136,000 starter assemblies, but over the next several years, it is expected that 160,000 assemblies will be needed each year. Total costs related to the starter assembly for last year were as follows: Direct material $252,960 Direct labor $163,200 Total overhead $408,000 Total $824,160 Further analysis of overhead revealed the following information: $183,600 of total overhead was variable. $109,000 of the fixed overhead were allocated costs that will continue even if the production of the starter assembly is discontinued. Tidnish Electronics, a reliable supplier, has offered to supply starter assembly units at $6.00 per unit. If the company buys the assembly from Tidnish, the vacated plant space could be used for storage and, in so doing, avoid $53,000 of outside storage charges currently incurred. REQUIRED By how much will Oxford Engineering's total profits change if they decide to buy the starter assembly from Tidnish Electronics instead of making it themselves? (Note: if the buy costs are less than the make costs, enter the difference as a positive number; if the buy costs are more than the make costs, enter the difference as a negative number.)
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 to supply the starter assembly used in these engines. The starter assembly is currently manufactured in Division 3 of Oxford Engineering. Last year, Division 3 manufactured 136,000 starter assemblies, but over the next several years, it is expected that 160,000 assemblies will be needed each year. Total costs related to the starter assembly for last year were as follows: Direct material $252,960 Direct labor $163,200 Total overhead $408,000 Total $824,160 Further analysis of overhead revealed the following information: $183,600 of total overhead was variable. $109,000 of the fixed overhead were allocated costs that will continue even if the production of the starter assembly is discontinued. Tidnish Electronics, a reliable supplier, has offered to supply starter assembly units at $6.00 per unit. If the company buys the assembly from Tidnish, the vacated plant space could be used for storage and, in so doing, avoid $53,000 of outside storage charges currently incurred. REQUIRED By how much will Oxford Engineering's total profits change if they decide to buy the starter assembly from Tidnish Electronics instead of making it themselves? (Note: if the buy costs are less than the make costs, enter the difference as a positive number; if the buy costs are more than the make costs, enter the difference as a negative number.)
Related questions
Oxford Engineering manufactures small engines. The engines aresold to manufacturers who install them in such products as lawnmowers. The company currently manufactures all the parts used inthese engines but is considering a proposal from an externalsupplier to supply the starter assembly used in these engines.
The starter assembly is currently manufactured in Division 3 ofOxford Engineering. Last year, Division 3 manufactured 156,000starter assemblies, but over the next several years, it is expectedthat 187,000 assemblies will be needed each year. Total costsrelated to the starter assembly for last year were as follows:
| Direct material | $290,160 |
| Direct labor | $184,080 |
| Total overhead | $624,000 |
| Total | $1,098,240 |
Further analysis of overhead revealed the followinginformation:
55% of total overhead was fixed.
$117,000 of the fixed overhead were allocated costs that willcontinue even if the production of the starter assembly isdiscontinued.
Tidnish Electronics, a reliable supplier, has offered to supplystarter assembly units at $5.00 per unit. If the company buys theassembly from Tidnish, sales of another product can be increased,resulting in additional contribution margin of $42,000.
REQUIRED
1. By how much will Oxford Engineering's total profits change ifthey decide to buy the starter assembly from Tidnish Electronicsinstead of making itthemselves? (Note: if the buycosts are less than the make costs, enter the difference as apositive number; if the make costs are less than the buy costs,enter the difference as a negative number.)
Oxford Engineering manufactures small engines. The engines aresold to manufacturers who install them in such products as lawnmowers. The company currently manufactures all the parts used inthese engines but is considering a proposal from an externalsupplier to supply the starter assembly used in these engines.Thestarter assembly is currently manufactured in Division 3 of OxfordEngineering. Last year, Division 3 manufactured 160,000 starterassemblies, but over the next several years, it is expected that200,000 assemblies will be needed each year. Total costs related tothe starter assembly for last year were as follows:
| Direct material | $329,600 |
| Direct labor | $179,200 |
| Totaloverhead | $800,000 |
| Total | $1,308,800 |
Further analysis of overhead revealed the followinginformation:
55% of total overhead was fixed.
$100,000 of the fixed overhead were allocated costs that willcontinue even if the production of the starter assembly isdiscontinued.
Tidnish Electronics, a reliable supplier, has offered to supplystarter assembly units at $5.50 per unit. If the company buys theassembly from Tidnish, sales of another product can be increased,resulting in additional contribution margin of $44,000.
1. By how much will Oxford Engineering's total profits change ifthey decide to buy the starter assembly from Tidnish Electronicsinstead of making itthemselves? (Note: if the buycosts are less than the make costs, enter the difference as apositive number; if the make costs are less than the buy costs,enter the difference as a negative number.)
INSOURCING/OUTSOURCING
Rentex Motor Drives is a division of a large U.S. manufacturer of industrial machinery and equipment. The parent company makes circulating pumps, high-capacity cooling fans, and compressors. Rentex Motor Dnves manufactures the electric motors that power much of this machinery and equipment. Rentex has a world-wide customer base and sells motors not only to its parent company, but also to other customers across the globe รขยย some of whom are direct competitors of Rentex's parent company.
Recently the company developed an electric motor assembly that will be a key component in a new circulating pump being manufactured and sold by one of Rentex's sister companies. The circulating pump will be sold to the manufacturers of oil-fired burners used for home heating. Each circulating pump will require a single electric motor assembly.
Rentex must now decide whether or not it should outsource or internally manufacture the motor assembly. To help with the analysis, a cross-functional team has been formed. Members of the team have been assigned the responsibility of analyzing from a total cost perspective whether or not Rentex should outsource or internally manufacture the electric motor assembly.
A European supplier that produces motors for a number of Fortune 500 companies has submitted a detailed proposal to Rentex for building the subassembly. However, confounding this analysis is an internal bias against outsourcing the motor, particularly since there is a strong union presence within Rentex's facilities. Furthermore, management at Rentex believes that the electric motor assembly design might be adapted in the future to enable its use in new applications in the chemical processing industry, thereby representing a future growth opportunity.
As an initial step the cross-functional team has gathered the required information to guide the firm's decision process.
Outsourcing Costs
Unit Costs: Rentex's marketing group estimates that volumes for the motor assembly are:
| Year 1 | 5,500 units |
| Year 2 | 6,250 units |
| Year 3 | 7,000 units |
The European supplier of electric motors has quoted a price of $105 per unit, FOB ex-works, 1&2 with 5% price decreases per year for Year 2, and again for Year 3. Remember รขยย the Year 3 price decrease is based off the Year 2 figure). The team assumes these price decreases are due to productivity improvements from higher volumes, the positive effects of learning at the supplier, and greater operating efficiencies. These prices have not been negotiated and the purchasing team believes that negotiation may lead to a lower unit price. If the new line of circulating pumps is successful, it is estimated that the life of the product cycle will be six years, reaching a peak of 8,000 units in Year 4, with a 10% reduction per year in volume after that as the product reaches the end of its life. It is estimated that the product will be completely phased out at the end of Year 6.
Shipping, handling, and receiving: Shipping, handling, and receiving costs at the buyer are estimated to be $15 per unit and should remain constant.
Tooling: The supplier has stated that it will cost $30,000 to fabricate the tooling and fixtures required to produce the electric motor. Rentex's policy is to assume ownership of tooling, so Rentex is responsible for the tooling costs. It's estimated that the tooling will have a usable life span of at least 6 years, with proper preventive maintenance (which the supplier has agreed to perform at no additional cost). The purchasing team plans to allocate the tooling costs evenly over the first three years.
Quality-related costs: The team has decided to include quality-related costs in its outsourcing calculations. During the investigation of the supplier, a team member collected data on the process that would likely produce the motors. The team estimates that the supplier's defect level, based on process measurement data, is 1,000 parts per million (ppm). Rentex's quality assurance department estimates that each supplier defect will cost Rentex $1,750 in direct nonconformance costs. Unfortunately, with quality problems there are always hidden costs that are difficult, if not impossible, to model.
Supplier capacity/safety stock: The team has concluded the supplier has available capacity to satisfy Rentex's current and near-term requirements for the motor. To mitigate supply chain risk, Rentex plans to hold one month's worth of the assembly as safety stock. The team assumes that this is a new cost each year.
Insourcing Costs
Rentex's cost engineering department has provided the following per unit cost estimates for internally manufacturing and assembling the motors during Year 1 of a three-year planning cycle:
| Direct labor | $19.75 | Cost of receiving components | $4.25 |
| Direct materials | $35.25 | Supplemental factory supplies | $2.15 |
| Transfer profit 3 | $21.75 |
Initial tooling and line modification costs: The start-up costs (including tooling) to modify existing production lines and equipment to accommodate production of the new motor will be $42,000, which will be spread out evenly over the first three years.
Depreciation expense: Depreciation expense on production equipment and tooling is considered a noncash item and is not included in the insourcing analysis.
Engineering design costs: Engineering costs to design, develop, and improve the production process will be $75,000 and will be spread evenly across the first three years of production.
Factory and corporate overhead: Overhead is allocated at 180% of direct labor costs.
Cost increases: In Years 2 and 3, management expects a 2% annual increase in direct material costs and a 3% increase in direct labor rates. (This increase is compounded so the increase in Year 3 costs is based off Year 2 cost figures).
Quality-related costs: The team estimates that Rentex's finished electric motor quality defects to be 2,500 ppm. Rentex's quality assurance department estimates that each defect costs the company $1,500 in nonconformance costs.
Preventive maintenance costs: Rentex's maintenance manager estimates that preventive maintenance of the production equipment required to produce the motors will cost $15,000 in Year 1, and will increase at the rate of 3% per year thereafter.
NOTES:
1. FOB (free on board) vessel means the supplier is responsible for transportation charges to the port in China.
2. Buyer is responsible for the cost and delivery of goods from the seller's location.
3. Transfer profit is the internal profit from selling to another unit in the company. This company views its units as profit centers, so profit must be included. Furthermore, the supplier has included profits in its quoted price.
Calculate the total cost per year for insourcing and outsourcing. Also calculate the cost per unit.
