Question

Required information [The following information applies to the questions displayed below] Morning Sky. Inc. (MSI), manufactures and sells computer games. The company has several product lines based on the age range of the target market. MSI sells both individual games as well as packaged sets. All games are in CD format, and some utilize accessories such as steering wheels, electronic tablets, and hand controls. To date, MSI has developed and manufactured all the CDs itself as well as the accessories and packaging for all of its products. The gaming market has traditionally been targeted at teenagers and young adults, however, the increasing affordability of computers and the incorporation of computer activities into junior high and elementary school curriculums has led to a significant increase in sales to younger children. MSI has always included games for younger children but now wants to expand its business to capitalize on changes in the industry. The company currently has excess capacity and is investigating several possible ways to improve profitability. MSI is considering outsourcing the production of the handheld control module used with some of its products, The company has received a bid from Monte Legend Co. (MLC) to produce 8,000 units of the module per year for $18.00 each. The following information pertains to MSI's production of the control modules: Direct materials $9

Direct labor 6
Variable manufacturing overhead 2
Fixed manufacturing overhead 5
Total cost per unit $22
MSi has determined that it could eliminate all variable costs if the control modules were produced externally, but none of the fixed overhead is avoidable. At this time, MSI has no specific use in mind for the spoce that is currently dedicated to the control module production. Required: 1. Compute the difference in cost between making and buying the control module. 2. Should MSi buy the modules from MLC or continue to make them? 3-a. Suppose that the MSI space currently used for the modules could be utilized by a new product line that would genetate $40.000 In annual profit. Recompute the difference in cost between making and buying under this scenario. 3-b. Does this change your recommendation to MSi? Complete this question by entering your answers in the tabs below. Compute the difference in cost between making and buying the control module. Complete this question by entering your answers in the tabs below. Compute the diference in cost between making and buying the control module
Difference in cost ____
Complete this question by entering your answers in the tabs below.
Should MSI buy the modules from MLC or continue to make them? Complete this question by entering your answers in the tabs below. Suppose that the MSI space currently used for the modules could be utilized by a new product line that would generate $40,000 in annual profit. Recompute the difference in cost between making and buying under this scenario. Difference in cost ____
Complete this question by entering your answers in the tabs below. Does this change your recommendation to MSI?

Answer 1

The cost per unit is $1 cheaper to make the modules in-house without considering opportunity costs. When factoring in the potential $40,000 profit from a new product line, it becomes $4 cheaper to buy the modules from MLC. Thus, MSI should outsource if they plan to introduce the new product line.

Step-by-step explanation:

Cost Difference Between Making and Buying the Control Module

To compute the difference in cost between making and buying the control module, we only consider the relevant costs, which are the costs that will change depending on the decision made. Since fixed overheads are unavoidable whether MSI makes or buys the modules, we exclude them from the calculation:

Cost to make (Direct materials + Direct labor + Variable manufacturing overhead) = $9 + $6 + $2 = $17 per unit

Cost to buy = $18 per unit from MLC

Difference in cost per unit = Cost to buy - Cost to make = $18 - $17 = $1

Recommendation on Buying or Making Modules

If MSI continues to make the modules, it spends $17 per unit versus the $18 per unit it would spend if it outsourced to MLC. Therefore, it is cheaper for MSI to make the modules in-house as long as the capacity is not used for another more profitable venture.

Impact of New Product Line on Cost Difference

If MSI can utilize the space for a new product line that generates $40,000 in annual profit, the opportunity cost of not using the space for the new product line must be considered. The new total cost of making in-house would include the lost profit from the new product line:

Lost profit (opportunity cost) = $40,000 per year
Total units produced = 8,000 units per year
Opportunity cost per unit = $40,000 / 8,000 units = $5 per unit

New cost to make (including opportunity cost) = $17 + $5 = $22 per unit
Difference in cost per unit (with opportunity cost) = $22 - $18 = $4

Revised Recommendation Considering the New Product Line

Considering the opportunity cost of the new product line, it is more economical for MSI to buy the control modules from MLC, as the cost per unit including the opportunity cost is higher if MSI continues to manufacture them in-house.