“In my opinion, we ought to stop making our own drums and accept that outside su
ID: 2436193 • 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?
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 Answer is complete but not entirely correct. Financial advantage Production Needs (disadvantage) of buying the drums 80,000 drums 100,000 drums 150,000 drums 48,000 (15,000) (67,500)
Explanation / Answer
Production Needs
Financial Advantage or (Disadvantage) of Buying the drums
1
80,000
Drums
$ 48000(see working note 1) Financial Advantage of
buying the drums
2
1,00,000
Drums
Indifferent whether you buy or Make it as there is no advantage
Or Disadvantage of buying the drums(see working note 2)
3
1,50,000
Drums
($ 1,20,000) i.e Financial disadvantage Of buying the drums
.(see working note 3)
Working Note:
1)Financial Advantage of buying if 80,000 drums are needed
Variable cost of manufacturing={ $12+0.7($6.50+$1.50)}=$ 17.6
Total Variable cost($17.6*80,000)= $ 14,08,000
Supervision Costs$60,000
Rent on new equipment$1,80,000
TOTAL COST OF MANUFACTURING $16,48,000
TOTAL COST OF BUYING($20*80,000units)$16,00,000
Financial Advantage of BUYING=$48,000
2.)Financial Advantage of buying if 100,000 drums are needed
Total Variable cost($17.6*1,00,000)=$ 17,60,000
Supervision Costs=$60,000
Rent on new equipment=$ 1,80,000
TOTAL COST OF MANUFACTURING =$ 20,00,000
TOTAL COST OF BUYING($20*1,00,000)=$ 20,00,000
Indifferent whether you buy or make in-house
3.)Financial Advantage of buying if 150,000 drums are needed
Total Variable cost($17.6*1,50,000)=$ 26,40,000
Supervision Costs= $60,000
Rent on new equipment= $1,80,000
TOTAL COST OF MANUFACTURING =$ 28,80,000
TOTAL COST OF BUYING($20*1,50,000)=$ 30,00,000
Financial Disadvantage of buying= $ 1,20,000
Production Needs
Financial Advantage or (Disadvantage) of Buying the drums
1
80,000
Drums
$ 48000(see working note 1) Financial Advantage of
buying the drums
2
1,00,000
Drums
Indifferent whether you buy or Make it as there is no advantage
Or Disadvantage of buying the drums(see working note 2)
3
1,50,000
Drums
($ 1,20,000) i.e Financial disadvantage Of buying the drums
.(see working note 3)
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