HAPPY HOMES INC. Happy Homes Inc. (HHI) makes a range of household appliances. In November 2002 it is considering a new type of fan that is to be introduced in 2003 and marketed at a price of $75. One of the components going into the fan is an electric motor. HHI generally makes the motors that go into its products. The production manager of HHI has come up with the following per unit estimate of the cost of making the motors (based on the expected production level of 100,000 motors):
Direct materials_________ $12.00
Direct labor _____________8.00
Supplies, power etc .______ 4.00
Insurance_______________ 0.10
Product design___________ 0.40
Supervisor's salary ________0.50
Allocated fixed factory costs_ 8.00
Total cost/unit___________ $33.00
Supplies, power, etc. consists of variable costs. Insurance refers to the additional insurance premium (fixed) that will be required only if the motors are made. Product design costs refer to $40,000 spent in the first quarter of 2002 on developing a suitable design for the fan motor. Supervisor's salary refers to the allocated salary of John Cutter, who supervises the production of all of HHI's motors. (This allocated cost is based on Cutter's present salary. He is expected to get a ten percent merit increase next year.) Allocated fixed factory costs refer to costs such as the production manager's salary, factory building depreciation, property taxes, etc. It also includes the cost of renting equipment. The equipment currently used by HHI for its existing motors can produce the new motors without any modification. However, capacity constraints will require HHI to rent additional equipment. HHI proposes to allocate the additional rental cost ($175,000 per year) to all the motors it produces since the equipment may be used to make any of the HHI motors. HHI has received an offer from Other Motor Company, which is willing to supply the motors at a price of $26.50 per motor.
Required 1. Should HHI make or buy motors? Why?
2. Assume HHI expects the demand for the new fan to be 50,000 units. Should it make or buy the motors? Why?
3. At what level of expected fan sales would HHI be indifferent between making and buying the motors?