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outsourcing decision in business and finance

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LO.3 (Outsourcing) Louisiana Luggage Components manufactures handles for suitcases

and other luggage. Attaching each handle to the luggage requires, depending on

the size of the luggage piece, between two and six standard fasteners, which the company

has historically produced. Th e costs to produce one fastener (based on capacity

operation of 4,000,000 units per year) are:

Direct material $0.08

Direct labor 0.06

Variable factory overhead 0.04

Fixed factory overhead 0.07

Total $0.25

Fixed factory overhead includes $100,000 of depreciation on equipment for which there

is no alternative use and no market value. Th e balance of the fi xed factory overhead

pertains to the salary of the production supervisor, Jeff Wittier. Wittier has a lifetime

employment contract and the skills that could be used to replace Brenda Gibbons, supervisor

of fl oor maintenance. She draws a salary of $50,000 per year but is due to retire

from the company.

Saratoga Suitcase Co. recently approached Louisiana Luggage Components with

an off er to supply all required fasteners for $0.19 per unit. Anticipated sales demand

for the coming year will require 4,000,000 fasteners.

a. Identify the costs that are relevant in this outsourcing decision.

b. What is the total annual advantage or disadvantage (in dollars) of outsourcing the

fasteners rather than making them?

c. What qualitative factors should be taken into account in making this decision?

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