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 who wishes to supply the starter assemblies used in these engines.
The starter assemblies are currently manufactured in Division 3 of Oxford Engineering. The costs relating to the starter assemblies for the past 12 months were as follows:
- Direct materials $200,000
- Direct manufacturing labor 150,000
- Manufacturing overhead 400,000
- Total $750,000
Over the past year, Division 3 manufactured 150,000 starter assemblies. The average cost for each starter assembly is $5 ($750,000 ÷ 150,000).
Further analysis of manufacturing overhead revealed the following information. Of the total manufacturing overhead, only 25% is considered variable. Of the fixed portion, $150,000 is an allocation of general overhead that will remain unchanged for the company as a whole if production of the starter assemblies is discontinued. A further $100,000 of the fixed overhead is avoidable if production of the starter assemblies is discontinued. The balance of the current fixed overhead, $50,000, is the division manager's salary. If production of the starter assemblies is discontinued, the manager of Division 3 will be transferred to Division 2 at the same salary. This move will allow the company to save the $40,000 salary that would otherwise be paid to attract an outsider to this position.
Required
1. Tidnish Electronics, a reliable supplier, has offered to supply starter-assembly units at $4 per unit. Because this price is less than the current average cost of $5 per unit, the vice president of manufacturing is eager to accept this offer. On the basis of financial considerations alone, should the outside offer be accepted? Show your calculations. (Hint: Production output in the coming year may be different from production output in the past year.)
2. How, if at all, would your response to requirement 1 change if the company could use the vacated plant space for storage and, in so doing, avoid $50,000 of outside storage charges currently incurred? Why is this information relevant or irrelevant?