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Opportunity Cost and Outsourcing Cost

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1. Baxter Corporation is working at full production capacity producing 10,000 units of a unique product, JKL. Manufacturing costs per unit for JKL follow:

Direct material $ 2
Direct manufacturing labor 3
Manufacturing overhead 5
$10

The unit manufacturing overhead cost is based on a variable cost per unit of $2 and fixed costs of $30,000 (at full capacity of 10,000 units). The non-manufacturing costs, all variable, are $4 per unit, and the selling price is $20 per unit. A customer, Jacksonville Company, has asked Baxter to produce 2,000 units of a modification of JKL to be called RST. RST would require the same manufacturing processes as JKL. Jacksonville Company has offered to share equally the non-manufacturing costs with Baxter. RST will sell at $15 per unit.

a. What is the opportunity cost to Baxter of producing the 2,000 units of RST (assuming that no overtime is worked)?

b. The Graves Company has offered to produce 2,000 units of JKL for Brown, so Brown can accept the Jacksonville offer. Graves Company would charge Baxter $14 per unit for the JKL. Should Baxter accept the Graves Company offer?

c. Suppose Baxter had been working at less than full capacity producing 8,000 units of JKL at the time the RST offer was made. What is the minimum price Baxter should accept for RST under these conditions (ignoring the $15 price mentioned previously)?

2. The Carpet Division of Home Products Corporation manufactures a single grade of residential grade carpeting. The division has the capacity to produce 500,000 square yards of carpet each year. Its current costs and revenues are shown here:

Sales (400,000 square yards) $2,000,000
Variable costs per square yard:
Production $2.00
SG&A 1.00
Fixed costs per square yard (based on 500,000 yard capacity)
Production $0.50
SG&A 1.00

The Housing Division currently purchases 40,000 yards of carpeting (of the grade produced by the Carpet Division) each year at a cost of $6.50 per square yard from an outside vendor.

Refer to Home Products Corporation. If the autonomous Housing and Carpet Divisions enter negotiations on the internal transfer of 40,000 square yards of carpeting, what is the Carpet Division's minimum price?

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Solution Preview

1a. Opportunity Cost = 2000 units of product JKL

Each unit = $20 in revenue = $20 x 2000 = $40,000
Less: Costs = 2000 [2+3+2+4] = $22,000

Contribution Margin = $40,000 - $22,000 = $18,000

b. In ...

Solution Summary

The financial situation of Baxter Corporation and Home Products Corporation are analyzed.

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