“In my opinion, we ought to stop making our own drums and accept that outside su
ID: 2450096 • 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 $19 per drum, we would be paying $5.45 less than it costs us to manufacture the drums in our own plant. Since we use 85,000 drums a year, that would be an annual cost savings of $463,250.” Antilles Refining’s current cost to manufacture one drum is given below (based on 85,000 drums per year): Direct materials $ 10.70 Direct labor 5.50 Variable overhead 1.50 Fixed overhead ($3.70 general company overhead, $2.05 depreciation, and, $1.00 supervision) 6.75 Total cost per drum $ 24.45 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 $255,000 per year. Alternative 2: Purchase the drums from an outside supplier at $19 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 ($85,000 per year) and direct materials cost per drum would not be affected by the new equipment. The new equipment’s capacity would be 125,000 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. To assist the managing director in making a decision, prepare an analysis showing the total cost and the cost per drum for each of the two alternatives given above. Assume that 85,000 drums are needed each year. a. What will be the total relevant cost of 85,000 drums if they are manufactured internally as compared to being purchased? b. What would be the per unit cost of each drum manufactured internally? (Round your answer to 2 decimal places.) c. Which course of action would you recommend to the managing director? Purchase from the outside supplier Manufacture internally Indifferent between the two alternatives 2a-1. What will be the total relevant cost of 100,000 drums if they are manufactured internally? 2a-2. What would be the per unit cost of drums? 2a-3. What course of action would you recommend if 100,000 drums are needed each year? Indifferent between the two alternatives Manufacture internally Purchase from the outside supplier 2b-1. What will be the total relevant cost of 125,000 drums if they are manufactured internally? 2b-2. What would be the per unit cost of drums? (Round your answer to 2 decimal places.) 2b-3. What course of action would you recommend if 125,000 drums are needed each year? Manufacture internally Purchase from the outside supplier Indifferent between the two alternative
Explanation / Answer
Cost of Making 85000 Drums
Continue to Make Drums
Buy Drums from Out Side
Direct Materials
$909500
Direct Labor
$327250
Variable Overhead
$89250
Fixed Overhead
General Company Overhead (3.7*85000/125000)*85000
$202300
Supervision Cost
$85000
Rent of new Equipment
$255000
Purchase cost of Drum
$1615000
Total Cost
$1868300
$1615000
Per Unit Cost
$21.98
$19
The company can make a savings of $ 253300 if the company go through the 2nd alternative of buy the drums outside. So the 2nd alternative should be selected
The total relevant cost of making 85000 drums internally =
Unit cost of each drum manufactured internally=$21.98
The company can make a savings of $ if the company go through the 2nd alternative of buy the drums outside.So the 2nd alternative should be selected
Cost of Making 100000 Drums
Continue to Make Drums
Buy Drums from Out Side
Direct Materials
$1070000
Direct Labor
$385000
Variable Overhead
$105000
Fixed Overhead
General Company Overhead
$238000
Supervision Cost
$85000
Rent of new Equipment
$255000
Purchase cost of Drum
$1900000
Total Cost
$2138000
$1900000
Per Unit Cost
$21.38
$19
(Assume that the Supervision Charges remains the Same ($85000)
2a-1: $2138000
2a-2: $21.38
2a-3: As the Company can save $238000,Purchase from Outside supplier alternative should be selected.
Cost of Making 125000 Drums
Continue to Make Drums
Buy Drums from Out Side
Direct Materials
$1337500
Direct Labor
$481250
Variable Overhead
$131250
Fixed Overhead
General Company Overhead
$297500
Supervision Cost
$85000
Rent of new Equipment
$255000
Purchase cost of Drum
$2375000
Total Cost
$2587500
$2375000
Per Unit Cost
$20.70
$19
(Assume that the Supervision Charges remains the Same ($85000)
2b1: $2587500
2b2: $20.70
2b3: As the Company can save $212500 the 2nd option of Purchase from outside supplier should recommend.
Continue to Make Drums
Buy Drums from Out Side
Direct Materials
$909500
Direct Labor
$327250
Variable Overhead
$89250
Fixed Overhead
General Company Overhead (3.7*85000/125000)*85000
$202300
Supervision Cost
$85000
Rent of new Equipment
$255000
Purchase cost of Drum
$1615000
Total Cost
$1868300
$1615000
Per Unit Cost
$21.98
$19
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