CMA Study Group

Donehart Corporation produces agricultural vehicles. Most of the component parts for these vehicles are subcontracted to reliable vendors. The final assembly of all vehicles is accomplished at Donehart's plant. Donehart's Engineering Department has developed a new fuel injection system that can be produced in-house because of the availability of production capacity. The first production run of the new fuel injection system has already been completed in-house. This 80-unit production run took 60 direct labor hours per unit to produce based on the cumulative average labor hours per fuel injection unit. Donehart has experienced an 80% learning curve with similar products, and this experience indicates that learning tends to cease by the time 640 systems are produced. Donehart's direct labor cost (including employee benefits) is $18 per direct labor hour. Donehart's management must decide whether to continue producing the fuel injection system or to subcontract the work. Donehart's purchasing agent has received a proposal from Midland, Inc., a company specializing in fuel injection systems. From past contracts, Midland has proven to be efficient and reliable. The terms of Midland's proposal are outlined below.

-	Donehart must supply all materials required for the fuel injection system units.
-	The first 80 units produced by Midland will require direct labor input at the rate of 56 hours per unit. Current direct labor cost is $20 per hour.
-	The direct labor cost charged to Donehart will be the hourly rate in effect at the time the work is performed. Midland is currently negotiating its labor contract, which includes a 4% increase in direct labor cost and should be applicable when Donehart signs the contract.
-	A learning curve factor of 75% will be applied through the first 640 units produced, and all benefits derived from the learning factor will accrue to Donehart.
-	Donehart must pay the actual labor cost incurred plus a 5% margin.