“In my opinion, we ought to stop making our own drums and accept that outside su
ID: 2435776 • Letter: #
Question
“In my opinion, we ought to stop making our own drums and accept that outside supplier’s offer,” said Wim Niewindt, managing director of Antilles Refining, N.V., of Aruba. “At a price of $20 per drum, we would be paying $5.45 less than it costs us to manufacture the drums in our own plant. Since we use 80,000 drums a year, that would be an annual cost savings of $436,000.” Antilles Refining’s current cost to manufacture one drum is given below (based on 80,000 drums per year):
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 $180,000 per year.
Alternative 2: Purchase the drums from an outside supplier at $20 per drum.
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 30%. The old equipment has no resale value. Supervision cost ($60,000 per year) and direct materials cost per drum would not be affected by the new equipment. The new equipment’s capacity would be 150,000 drums per year.
The company’s total general company overhead would be unaffected by this decision. (Round all intermediate calculations to 2 decimal places.)
Required:
1. Assuming that 80,000 drums are needed each year, what is the financial advantage (disadvantage) of buying the drums from an outside supplier?
2. Assuming that 100,000 drums are needed each year, what is the financial advantage (disadvantage) of buying the drums from an outside supplier?
3. Assuming that 150,000 drums are needed each year, what is the financial advantage (disadvantage) of buying the drums from an outside supplier?
(For all requirements, enter any "disadvantages" as a negative value. Do not round intermediate calculations.)
Direct materials $ 12.00 Direct labor 6.50 Variable overhead 1.50 Fixed overhead ($2.90 generalcompany overhead, $1.80 depreciation,
and, $0.75 supervision) 5.45 Total cost per drum $ 25.45 Production Needs Financial advantage disadvantage) of buving the drums 80,000 drums 2. 100,000 drums 3 150,000 drums
Explanation / Answer
If 80000 drums are needed each year Differential cost per annum Total Differential cost - 80000 drums Make Buy Make Buy Outside Suppliers price 20 1600000 Direct Materials 12 960000 Direct Labor 4.55 364000 (6.50*70%) Variable Overhead 1.05 84000 (1.50*70%) Supervision 0.75 60000 Equipment Rental 2.25 180000 (180000/80000) 20.6 20 1648000 1600000 Financial advantage of buying drums (1648000-1600000) $48,000 If 100000 drums are needed each year Differential cost per annum Total Differential cost - 80000 drums Make Buy Make Buy Outside Suppliers price 20 2000000 Direct Materials 12 1200000 Direct Labor 4.55 455000 (6.50*70%) Variable Overhead 1.05 105000 (1.50*70%) Supervision 0.75 75000 Equipment Rental 1.8 180000 (180000/100000) 20.15 20 2015000 2000000 Financial advantage of buying drums (2015000-2000000) $15,000 If 150000 drums are needed each year Differential cost per annum Total Differential cost - 80000 drums Make Buy Make Buy Outside Suppliers price 20 3000000 Direct Materials 12 1800000 Direct Labor 4.55 682500 (6.50*70%) Variable Overhead 1.05 157500 (1.50*70%) Supervision 0.75 112500 Equipment Rental 1.2 180000 (180000/150000) 19.55 20 2932500 3000000 Financial disadvantage of buying drums (2932500-3000000) ($67,500)
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