mohave corp. is considering outsourcing production of the umbrella tote bag included with some of its products. the company has received a bid from a supplier in vietnam to produce 8,000 units per year for $7.50 each. mohave has the following information about the cost of producing tote bags: direct materials $ 3 direct labor 2 variable manufacturing overhead 1 fixed manufacturing overhead 2 total cost per unit $ 8 mohave has determined that all variable costs could be eliminated by outsourcing the tote bags, while 60 percent of the fixed overhead cost is unavoidable. at this time, mohave has no specific use in mind for the space currently dedicated to producing the tote bags. required: 1. compute the difference in cost between making and buying the umbrella tote bag. 2. based strictly on the incremental analysis, should mohave buy the tote bags or continue to make them? 3-a. suppose that the space mohave currently uses to make the bags could be utilized by a new product line that would generate $10,000 in annual profits. recompute the difference in cost between making and buying the umbrella tote bag. 3-b. does this change your recommendation to mohave?

2. Based strictly on the incremental analysis, Mohave should not buy the tote bags but continue to make them because it incurs more incremental costs buying.

3a. The computation of the difference in cost (Incremental Costs) between making and buying the umbrella tote bag is as follows:

Incremental Analysis:

Make Buy Difference

Incremental costs:

Direct materials $3

Direct labor 2

Variable overhead 1

Fixed overhead $0.80

Total avoidable costs $6.80 $54,400 $50,000 $4,400

3b) The recommendation at No. 2 above changes with the generation of $10,000 in profits from the alternative use of the facility.

Production units = 8,000

Outside supplier's cost per unit = $7.50

Total purchase cost = $60,000

Total purchase cost with alternative profit = $50,000 ($60,000 - $10,000)

Internal production costs:

Direct materials $3

Direct labor 2

Variable manufacturing overhead 1

Fixed manufacturing overhead 2

Total cost per unit $ 8

Unavoidable fixed costs = 60%

Avoidable fixed costs = 40% = $0.80 ($2 x 40%)

Unavoidable fixed cost per unit = $1.20

Total unavoidable fixed cost = $9,600 (8,000 x $1.20)

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