Check Your Work That old equipment for producing carburetors is worn out,\" said
ID: 341776 • Letter: C
Question
Check Your Work That old equipment for producing carburetors is worn out," said Bill Seebach, president of Hondrich Company. "We need to make a decision quickly."The company is trying to decide whether it should rent new equipment and continue to make its carburetors internally or whether it should discontinue production of its carburetors and purchase them from an outside supplier. The alternatives follow Alternative 1: Rent new equipment for producing the carburetors for $115,000 per year. Alternative 2: Purchase carburetors from an outside supplier for $16.95 each. Hondrich Company's costs per unit of producing the carburetors internally (with the old equipment) are given below. These costs are based on a current activity level of 25,000 units per year: $5.10 8.00 2.80 Direct labour Fixed overhead ($2.30 supervision, $1.80 depreciation, and $4.00 general company overhead) Total cost per unit $24.00 The new equipment would be more efficient and, according to the manufacturer labour costs and variable overhead costs by 25%. Supervision oost (S57.500 per year) and dred maras cost per unit would not be affected by the new equipment. The new equipment's capacity would be 50,000 would reduce direct per year The total general company overhead would be unaffected by this decision Required: total costs for each of the two altenatives given above. Assume that 25,000 each year are neededExplanation / Answer
1.
Alternative 2: Purchase carburetors
Depreciation on old equipment is a sunk cost and hence irrelevant. The general company overhead would not be affected by the decision and hence is irrelevant.
a. Total relevant cost (25000 subassemblies): $502500
b. Per unit cost of subassembly: $24.10
Per unit relevant cost of subassembly = $20.10
Per unit cost of subassembly manufactured internally = $20.10 + General company overhead $4 = $24.10
c. Purchase from the outside supplier.
2.
a-1. Total relevant cost (46000 subassemblies): $779700
a-2. Per unit cost of subassembly: $19.12
Total relevant cost of subassembly = $779700
Total cost of subassembly manufactured internally = $779700 + General company overhead ($4 x 25000) = $779700 + $100000 = $879700
Per unit cost of subassembly = $879700/46000 = $19.12
a-3. Indifferent between the two alternatives.
b-1. Total relevant cost (50000 subassemblies): $832500
b-2. Per unit cost of subassembly: $18.65
Total relevant cost of subassembly = $832500
Total cost of subassembly manufactured internally = $832500 + General company overhead ($4 x 25000) = $832500 + $100000 = $932500
Per unit cost of subassembly = $932500/50000 = $18.65
b-3. Manufacture internally.
Alternative 1:Rent new equipment
Alternative 2: Purchase carburetors
25000 subassemblies 25000 subassemblies Per unit Total Per unit Total Rent of new equipment 4.60 115000 0 0 Direct materials 5.10 127500 0 0 Direct labor 6.00 150000 0 0 Variable overhead 2.10 52500 0 0 Supervision 2.30 57500 0 0 Purchase price 0 0 16.95 423750 Total relevant cost $ 20.10 502500 16.95 423750