Kane company is considering outsourcing a key component. Areliable supploer has quoted a price of 64.50 per unit. Thefollowing costs of component when manufactured in house areexpressed on a per unit basis:
Direct material 23.40
Direct Labor 16.10
Variable Overhead 26.70
Fixed Overhead 6.90
total cost 73.10
a.) What assumption need to be made about the behavior ofoverhead costs for Kane in order to analyze the outsourcingdecision?
b.) Should Kane company outsource the component? Yes or noWhy?
c.) What other factors are relevent to this decision? Yes or NoWhy?
Kane company is considering outsourcing a key component. Areliable supploer has quoted a price of 64.50 per unit. Thefollowing costs of component when manufactured in house areexpressed on a per unit basis:
Direct material 23.40
Direct Labor 16.10
Variable Overhead 26.70
Fixed Overhead 6.90
total cost 73.10
a.) What assumption need to be made about the behavior ofoverhead costs for Kane in order to analyze the outsourcingdecision?
b.) Should Kane company outsource the component? Yes or noWhy?
c.) What other factors are relevent to this decision? Yes or NoWhy?
Related questions
Question 5: Kane Company is considering outsourcing a keycomponent. A reliable supplier has quoted a price of $64.50 perunit. The following costs of the component when manufacturedin-house are expressed on a per unit basis (assume Direct Labor isa variable cost):
DirectMaterials $23.40
DirectLabor 16.10
Variable Overhead 26.70
Fixed Overhead $ 6.90
Totalcosts $73.10
a) What assumptions need to be made about the behavior ofoverhead costs for Kane in order to analyze the outsourcingdecision?
| SAVING ITEMS | RELEVANT |
| Direct Materials Cost | =$ |
| Direct labor Costs | =$ |
| Variable overhead costs | =$ |
| Fixed overhead costs | =$ |
| ADDITIONAL COSTS | RELEVANT COSTS |
| Direct labor Costs | =$ |
| Direct materials Costs | =$ |
| Fixed Overhead Costs | =$ |
| Variable overhead cost | =$ |
b) Should Kane Company outsource the component? ???
c) What other factors are relevant to this decision? ???
Hello, I need a solution for this question please.
Make-or-Buy Decisions
Organizations are often faced with a make-or-buy decision-adecision of whether to make or to buy components or services usedin making a product or providing a service. For example, a factorycan make a component for a product in-house or purchase it from anoutside supplier.
Example: Each year, Ingmar Company produces13,100 units of a component used in microwave ovens. An outsidesupplier has offered to supply the part for $1.28. The unit costis:
Round intermediate calculations to the nearest cent. Use roundedanswers in subsequent computations, if required.
| Direct materials | $0.75 |
| Direct labor | 0.25 |
| Variable overhead | 0.18 |
| Fixed overhead | 2.42 |
| Total unit cost | $3.60 |
The alternatives for Ingmar Company are: continue making thecomponent in-house, or purchasing the component from the outsidesupplier. Assuming that none of the fixed cost is avoidable,determine which alternative is more cost effective: - Select youranswer -Make the component in-housePurchase from the outsidesupplierItem 1 . If Ingmar accepts the offer to purchase from theoutside supplier, operating income will be $ - Select your answer-higherlowerItem 3 .
Now suppose that Ingmar Company rents machinery capable ofmaking 13,100 units of the component per year and the annual leasecost is $13,100 (this is included in the fixed overhead for thecomponent). The lease can be cancelled whenever Ingmar wantswithout penalty. The machinery lease cost is - Select your answer-relevantnot relevantItem 4 . Determine which alternative is morecost effective: - Select your answer -Make the componentin-housePurchase from the outside supplierItem 5 . If Ingmaraccepts the offer to purchase from the outside supplier, operatingincome will be $ - Select your answer -higherlowerItem 7 .
The make-or-buy decision may be more complex than either examplenoted above. However, the key idea is that relevant costs andbenefits must be distinguished from irrelevant costs and benefits.Therefore, no matter how many costs are involved, the analyst candetermine the overall quantitative impact of making versus buying.Finally, the qualitative factors must be considered. For example,perhaps Ingmar Company believes that it can do a higher quality jobthan the outside supplier. Then, even if it were less expensive topurchase outside, the company could continue to make the componentin-house. Or, perhaps Ingmar Company could use the freed up spaceand workers to make a new, potentially very profitable, product.Then the company might decide to outsource the component even if itappears in the short-run to be a more costly approach.
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 â 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 â 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.
