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# Outsourcing Cost Per Unit

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ABC's production line of the Widget gadget has a fixed cost of \$200,000 and the variable cost is \$5.00 per unit.

A. If the company sells the first 10,000 units at a price of \$20 and then sells all additional units at \$15 per unit, what is the break-even point?

B. Suppose that the company is considering outsourcing this to DEF company. If so, it will save the fixed and variable costs per unit. If the cost of outsourcing is \$13 per unit, over what range would each of the production options (in-house and outsourcing) be preferred? Assume that the price per unit will remain the same whether it produces the product internally or outsources it.

C. Suppose that the company has determined that its demand is going to be 10,000 units. What is the outsourcing cost per unit that makes the two production alternatives equal to each other? Assume that the price per unit will remain the same whether it produces the product internally or out sources it.

D. Johndoe Company is interested in buying the Widget gadget from ABC. Johndoe Company is open to letting ABC manufacture them in-house or outsource them under certain conditions. Johndoe will only buy the outsourced if ABC reduces the selling price to \$18 per unit. Also, if ABC does outsource this, Johndoe will only buy 8,000 units. On the other hand, if ABC produces the product internally, Johndoe will be willing to pay \$20 per unit for all the products and Johndoe will buy 12,000 widgits. Economically, which option (produce internally or outsource) is better for ABC?

#### Solution Preview

ABC's production line of the Widget gadget has a fixed cost of \$200,000 and the variable cost is \$5.00 per unit.

A.

Assume the company sells x units.
When x=10000, cost is: 200000+5*10000=250000
Profit: 20*100000=20000.
Therefore, we need to sell more than 10000 to obtain the break-even point.
200000+5x=20*10000+15*(x-10000)
X=15000.

B. ...

#### Solution Summary

The outsourcing costs per unit are examined. The products for internal sources are determined.

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## Upstate Mechanical: Outsourcing Decision

Upstate Mechanical, Inc. has been producing two bearings, components T79 and B81, for use in production. Data regarding these two components follow.

Upstate Mechanical's annual requirement for these components is 8,000 units of T79 and 11,000 units of B81. Recently, management decided to devote additional machine time to other product lines, leaving only 41,000 machine hours per year for producing the bearings. An outside company has offered to sell Upstate Mechanical its annual supply of bearings at prices of \$11.25 for T79 and \$13.50 for B81. Management wants to schedule the otherwise idle 41,000 machine hours to produce bearings so that the firm can minimize costs (maximize net benefits).

Required:
1. Compute the net benefit (loss) per machine hour that would result if Upstate Mechanical accepts the supplier's offer of \$13.50 per unit for component B81.
2. Choose the correct answer. Upstate Mechanical will maximize its net benefits by:
a. purchasing 4,800 units of T79 and manufacturing the remaining bearings.
b. purchasing 8,000 units of T79 and manufacturing 11,000 units of B81.
c. purchasing 11,000 units of B81 and manufacturing 8,000 units of T79.
d. purchasing 4,000 units of B81 and manufacturing the remaining bearings.
e. purchasing and manufacturing some amounts other than those given above.
3. Suppose management has decided to drop product T79. Independently of requirements (1) and (2), assume that the company's idle capacity of 41,000 machine hours has a traceable, avoidable annual fixed cost of \$44,000, which will be incurred only if the capacity is used. Calculate the maximum price Upstate Mechanical should pay a supplier for component B81.

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