Mike's Mountain Bikes (MMB) manufactures part #822 for its bikes. The #822 cost per unit is $61.00 at an annual volume of 20,000 units. MMB's total fixed manufacturing overhead is $440,000. Kami Manufacturing offers to sell MMB the same part for $58 per unit at their current volume use of 20,000 units. MMB is only interested in outsourcing the part if MMB realizes a savings of at least $150,000. If MMB does buy the part from Kami, MMB will be able reduce its fixed costs by $8 per unit of #822, and free up manufacturing space used to manufacture the #822 which it will use to store inventory currently kept at a leased storage facility which costs MMB $240,000 per year. If the inventory is moved out of the leased facility, MMB can reduce the space it leases in that facility by half and realize a 50% lease payment savings.

If part #822 is outsourced, what is the net impact on operating profit?

Question

Mike's Mountain Bikes (MMB) manufactures part #822 for its bikes. The #822 cost per unit is $61.00 at an annual volume of 20,000 units. MMB's total fixed manufacturing overhead is $440,000. Kami Manufacturing offers to sell MMB the same part for $58 per unit at their current volume use of 20,000 units. MMB is only interested in outsourcing the part if MMB realizes a savings of at least $150,000. If MMB does buy the part from Kami, MMB will be able reduce its fixed costs by $8 per unit of #822, and free up manufacturing space used to manufacture the #822 which it will use to store inventory currently kept at a leased storage facility which costs MMB $240,000 per year. If the inventory is moved out of the leased facility, MMB can reduce the space it leases in that facility by half and realize a 50% lease payment savings.

If part #822 is outsourced, what is the net impact on operating profit?

BlackTom AI · Accepted Answer

We begin by laying out the scenario and the two alternatives clearly so we can compare operating profits.

Current situation (do not outsource):
- Variable manufacturing cost: 61 per unit × 20,000 units = 1,220,000
- Fixed manufacturing overhead: 440,000
- Storage facility cost for inventory: 240,000
Total current operating cost: 1,220,000 + 440,000 + 240,000 = 1,900,000

Outsource scenario (buy from Kami):
- Purchase cost from Kami: 58 per unit × 20,000 units = 1,160,000
- Reduction in fixed costs: fixed costs can be reduced by 8 per unit × 20,000 = 160,000, so new fixed costs = 440,000 − 160,000 = 280,000
- Storage space for inventory: by outsourcing, MMB can move inventory out of the leased storage facility, eliminating that 240,000 cost
- Lease space savings: freeing up space allows a reduction in lease payments by half, i.e., 50% of the current lease cost of 240,000 → saving 120,000, leaving 120,000 in lease costs
Total outsourcing cost: 1,160,000 + 280,000 + 0 + 120,000 = 1,560,000

Net impact on operating profit (outsourcing minus current):
1,900,000 − 1,560,000 = 340,000 increase in operating profit (i.e., a net saving of 340,000)

Now we evaluate each answer option and note why it is correct or incorrect given this calculation.

Option a) Net savings of 1,200,000: This would imply an enormous cost reduction far exceeding all identified components (60k variable savings + 160k fixed + 240k storage + 120k lease = 580k potential savings, still less than 1.2M). Therefore this is overstated and incorrect.

Option b) Net savings of 780,000: This is also much larger than the total incremental savings from the outsourcing scenario. It does not align with the breakdown of variable, fixed, storage, and lease effects. Therefore this is incorrect.

Option c) Net savings of 900,000: Similar to the previous two, this amount cannot be reconciled with the component-wise savings calculated (the maximum plausible incremental savings from the move is 580k, and even if double-counting were possible, it would not reach 900k). Therefore this is incorrect.

Option d) Net savings of 120,000: This is closer to some individual components (e.g., half of the storage or lease alone), but it still omits other savings from variable cost, fixed-cost reduction, and the other lease/space effects. The full calculation shows a larger net impact than 120,000, so this is incorrect.

Option e) Net additional losses of 100,000: The computed net impact is an increase in operating profit (a positive 340,000), not a loss. Therefore this is incorrect.

Summary note: When combining all the relevant effects—lower purchase cost (60,000), fixed-cost reduction (160,000), removal of storage cost (240,000), and partial lease cost savings (120,000)—the total net effect is a 340,000 reduction in operating costs, i.e., a 340,000 increase in operating profit. None of the provided options matches this result, indicating a discrepancy between the calculated outcome and the listed choices.

2025Spring-ACC2002-02 Quiz 3 - Relevant Costs

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