¶ … 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...
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…
References
Jay, B. (2004). Relevant costs for decision-making. Accounting Articles for Students, retrieved June 23, 2011 from http://www.accountancy.com.pk/articles_students.asp?id=142
McAfee, R., Mialon, H., and Mialon, S. (2007). Do Sunk Costs Matter? Retrieved June 23, 2011 http://www.mcafee.cc/Papers/PDF/SunkCostFolly.pdf
BMC Global The entrance of an automotive MNE in China Behemoth Motors Corp. (BMC) is a major manufacturer of automobiles in the United States. BMC has decided to include a Global Positioning System navigator (GPSN) in all of its Sports Utility Vehicles (SUV) beginning with the 2011 model year. Wally Wizard, the GPSN manager, has been approached by Far East Enterprises, Ltd. (FEE) who has offered to outsource these units for MBC.