Problem 12-28 Make or Buy Analysis [LO12-3 \"In my opinion, we ought to stop mak
ID: 2416433 • Letter: P
Question
Problem 12-28 Make or Buy Analysis [LO12-3 "In my opinion, we ought to stop making our own drums and accept that outside supplier's offer," said Wim Niewindt, managing director of Antiles Refining, N.V., of Aruba. "At a price of $21 per drum, we would be paying $6.25 less than it costs us to manufacture the drums in our own plant. Since we use 75,000 drums a year, that would be an annual cost savings of $468,750." Antilles Refining's current cost to manufacture one drum is given below (based on 75,000 drums per year): Direct materials Direct labor Variable overhead Fixed overhead ($3.40 general company overhead, $1.90 10.65 9.00 1.60 depreciation, and, $0.70 supervision) 6.00 Total cost per drum $27.25 A decision about whether to make or buy the drums is especially important at this time because the equipment being used to make the drums is completely worn out and must be replaced. The choices facing the company are: Alternative 1: Rent new equipment and continue to make the drums. The equipment would be rented for Alternative 2: Purchase the drums from an outside supplier at $21 per drum $157,500 per year. The new equipment would be more efficient than the equipment that Antilles Refining has been using and, according to the manufacturer, would reduce direct labor and variable overhead costs by 25%. The old equipment has no resale value. Supervision cost ($52,500 per year) and direct materials cost per drum would not be affected by the new equipment. The new equipment's capacity would be 105,000 drums per year. The company's total general company overhead would be unaffected by this decision. (Round all intermediate calculations to 2 decimal places.)Explanation / Answer
1-a
Calculation of Total Relevant Cost of 75000 Drums
(If they are manufactured internally)
Rent of New Equipment
$ 157,500
Direct material Cost (75000*10.65)
$ 798,750
Direct Labor Cost (75000*9.00)*(1-25%)
$ 506,250
Variable Overheads (75000*1.60)*(1-25%)
$ 90,000
Supervision
$ 52,500
Total Relevant Cost
$ 1,605,000
Note: Companies General overhead is Irrelevant costs and Depreciation shall be nil due to Machine on rent.
1-b:
Calculation of Per unit cost of Drum :
(If they are manufactured internally)
Total Cost of 75000 Drums
$ 1,605,000
Per unit cost of Drum = 1605000/75000 =
$ 21.40
1-c:
The manufacturing cost per drum ($21.40) is more than Purchase cost per drum ($21.00)
Hence it is better to purchase from outside supplier
2a-1:
Calculation of Total Relevant Cost of 87500 Drums
(If they are manufactured internally)
Rent of New Equipment
$ 157,500
Direct material Cost (87500*10.65)
$ 931,875
Direct Labor Cost (87500*9.00)*(1-25%)
$ 590,625
Variable Overheads (87500*1.60)*(1-25%)
$ 105,000
Supervision
$ 52,500
Total Relevant Cost
$ 1,837,500
Note: Companies General overhead is Irrelevant costs and Depreciation shall be nil due to Machine on rent.
2a-2:
Calculation of Per unit cost of Drum :
(If they are manufactured internally)
Total Cost of 87500 Drums
$ 1,837,500
Per unit cost of Drum = 1837500/87500 =
$ 21.00
2a-3:
The manufacturing cost per drum ($21.00) is equal to Purchase cost per drum ($21.00)
Hence it is indifference between two alternatives
1-a
Calculation of Total Relevant Cost of 75000 Drums
(If they are manufactured internally)
Rent of New Equipment
$ 157,500
Direct material Cost (75000*10.65)
$ 798,750
Direct Labor Cost (75000*9.00)*(1-25%)
$ 506,250
Variable Overheads (75000*1.60)*(1-25%)
$ 90,000
Supervision
$ 52,500
Total Relevant Cost
$ 1,605,000
Note: Companies General overhead is Irrelevant costs and Depreciation shall be nil due to Machine on rent.
1-b:
Calculation of Per unit cost of Drum :
(If they are manufactured internally)
Total Cost of 75000 Drums
$ 1,605,000
Per unit cost of Drum = 1605000/75000 =
$ 21.40
1-c:
The manufacturing cost per drum ($21.40) is more than Purchase cost per drum ($21.00)
Hence it is better to purchase from outside supplier
2a-1:
Calculation of Total Relevant Cost of 87500 Drums
(If they are manufactured internally)
Rent of New Equipment
$ 157,500
Direct material Cost (87500*10.65)
$ 931,875
Direct Labor Cost (87500*9.00)*(1-25%)
$ 590,625
Variable Overheads (87500*1.60)*(1-25%)
$ 105,000
Supervision
$ 52,500
Total Relevant Cost
$ 1,837,500
Note: Companies General overhead is Irrelevant costs and Depreciation shall be nil due to Machine on rent.
2a-2:
Calculation of Per unit cost of Drum :
(If they are manufactured internally)
Total Cost of 87500 Drums
$ 1,837,500
Per unit cost of Drum = 1837500/87500 =
$ 21.00
2a-3:
The manufacturing cost per drum ($21.00) is equal to Purchase cost per drum ($21.00)
Hence it is indifference between two alternatives