Behemoth Motor Corporation's GPS navigator system manufacturing decision analysis

¶ … Wally Wizard, the manager of Global Positioning Navigator System (GPNS) at Behemoth Motor Corporation (BMC), have two alternatives to manufacture GPNS; to make in-house or outsourced to a Chinese company, Far East Enterprises (FEE). So in order to make a decision, cost vs. benefit analysis for these alternatives will be determined to find out the per unit cost of each alternatives, and then better option will be selected.

So for first alternative, If Willy Wizard decides to manufacture these on the company facility then following costs will be incurred,

Relevant Costs / Benefits

$/unit

Direct Material

Direct Labor (6hrs @ 28/hr)

Factory Floor Space Charges (16,000 sq. ft. At $2.50 per sq. ft. per month allocated over 8,000 units per month)

Supervisory labor (monthly cost of $56,000 allocated over 8,000 units per month)

General company overhead ($640,000 / month allocated over 8,000 units / month)

Wastage/Failure Cost (2% of 8,000 units) * ($425/8000 units)

8.5

Total Unit Cost

Since 2% of the total monthly product comes under failure due to quality control, so it will be the part of the relevant cost while making a decision as wastages. So the total per unit cost of producing GPNS will be 433.5/unit not $425. So, the total cost of manufacturing 8,000 units will be $3,468,000.

On the other hand, if Wally Wizard chooses the other alternative and decides to outsource the GPNS systems from Chinese company FEE, then the charges BMC have to bear for the acquisition of per unit of GPN systems will be,

Relevant Costs / Benefits

$/unit

Cost of Outsourcing

Penalty to Employees Union ({$66,000*4 years}/{8000 units *24 months)

1.375

Storage rent saved ($5,000/8,000 units)

(0.625)

Factory Floor Space Charges (16,000 sq. ft. At $2.50 per sq. ft. per month allocated over 8,000 units per month) IRRELEVANT

5

Total Unit Cost

So per unit cost (after including all relevant costs) of the GPNS when manufactured by FEE is lower than manufacturing in-house. But there are other costs and benefits to be considered when outsourced.

Opportunity cost is one that BMC Company has to bear if they outsource the project in shape of penalty to employees union. If the company will outsource the project then they have to lay off employees and pay penalty to union. So this penalty is resulting from the decision to outsource so it is an opportunity cost for the company.

The other important thing to be considered is the opportunity benefit in shape of rent saved by utilizing the factory floor. If the GPN system is outsourced then the factory floor space will be free for storage. Since BMC is using rented storage facilities for the storage of material and they have to pay $5,000 for it each month. So in outsourcing, BMC can use half of the blank factory floor as storage house which enables them to save extra $5,000 per month which they have to pay to the rental storage service providers.

Another cost to be considered is the sunk cost of the factory floor which company has to bear no matter which alternative BMC is using. They have to pay $5 per square feet each month whether they use it or not. So it is a sunk cost which is already incurred and cannot be recovered. Although sunk cost is irrelevant to decision making but it has to be included here to calculate actual cost even though this cost will not create any difference in final cost (McAfee, Mialon, and Mialon, 2007).

So, by adding all costs and subtracting the benefits, per unit cost of the GPN systems if they are outsourced and acquired from Chinese company FEE is less than per unit cost of Manufacturing with a differential of $27.75 (433.5-405.75). This means that if Willy Wizard will outsource the project then BMC can save $27.75 on each unit. So it is recommended for Willy Wizard to outsource the manufacturing of the GPNS.

RELEVANCE OF SUNK COSTS

Sunk costs are those costs which have already been incurred and cannot be recovered. Such a cost is spent and it is unrecoverable. They do not affect any future costs and cannot be changed by any current or future action. Sunk costs are irrelevant to decisions since they are already occurred and cannot be changed so it does not create any difference in the two alternatives thus contributing nothing to decision making process (Jay, 2004).