Make/Buy

Make or Buy Relevant Cost Analysis Tutorial

Overview of the Decision Situation

  • Company: Wheelcovers.com

  • Product: Turbo Z Model (plastic wheel covers)

  • Production and Sales: 5,000 sets of Turbo Z wheels annually, where each set consists of four wheels

  • Selling Price per Set: $125

  • Cost per Unit on Financial Statements: $70

  • Gross Margin: 44%

Outsourcing vs. In-House Production

  • Outside Supplier Offer: Produce Turbo Z for $60 per unit

  • Responsibilities: Supplier will take over all manufacturing, while Wheelcovers.com maintains existing sales channels

  • Manufacturing Costs:

    • Variable Cost per Set: $40

    • Effect of Outsourcing: Supplier covers all manufacturing costs

  • Injection Molding Equipment:

    • Current Lease: $50,000 per year

    • Lease Expiry: Current lease expires in one month, can be renewed at the same cost

Financial Analysis Setup

  • Two Scenarios for Analysis:

    • Continue as is

    • Outsource production

  • Revenue Consistency: Sales remain the same at $625,000 regardless of chosen option

    • Revenue is considered irrelevant for decision-making

Cost Analysis

Costs to Continue In-House Production

  • Variable Production Costs:

    • Total: $200,000 for 5,000 sets at $40 each

  • Fixed Manufacturing Costs: $150,000 in total allocated to product line

    • Direct Fixed Cost for Turbo Z (equipment lease): $50,000, will be saved if outsourced

    • Remaining Allocated Costs: $100,000 will continue irrespective of outsourcing

Costs to Outsource Production

  • Relevant Cost Savings if Outsourced:

    • Elimination of Variable Production Costs: Savings of $200,000

    • Elimination of Direct Fixed Cost: Savings of $50,000

  • New Relevant Costs if Outsourcing:

    • Supplier Charge: $60 per set for 5,000 sets, $300,000 total

  • Total Relevant Costs for Outsourcing:

    • Variable Costs: $300,000

    • Variable Selling Costs: Remain the same ($50,000)

    • Fixed Selling and Administration Costs: Remain allocated

Opportunity Costs

  • Additional Revenue from Renting Space:

    • Potential Revenue: $40,000 per year if outsourcing, considered a relevant benefit

Summary of Product Line Profit

  • Current Profit from Turbo Z under In-House Production:

    • Profit: $75,000

  • Projected Profit from Outsourcing:

    • Profit: $65,000

  • Analysis of Relevant Costs:

    • Negative Impact: $10,000 decrease in income if production is outsourced

Additional Considerations

  • Relationship Management:

    • Need to manage the supplier relationship for production and payables

  • Internal Workload Changes:

    • Transition from raw materials to finished goods inventory

  • Quality Control Concerns:

    • Potential issues with product quality when outsourced

  • Inventory Management:

    • Adjustments may be required to maintain inventory levels and prevent stockouts

  • Evaluating Additional Capacity:

    • Consideration of capacity for other products post-outsource

Conclusion

  • Important to carefully consider both numerical and qualitative implications before making a decision to outsource production.

  • The decision impacts not only financial metrics but also operational aspects of Wheelcovers.com.