“In my opinion, we ought to stop making our own drums and accept that outside su
ID: 2487128 • 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 $18 per drum, we would be paying $6.65 less than it costs us to
manufacture the drums in our own plant. Since we use 65,000 drums a year, that
would be an annual cost savings of $432,250.” Antilles Refining’s current cost to
manufacture one drum is given below (based on 65,000 drums per year):
Direct materials
$
10.50
Direct labor
7.50
Variable overhead
1.50
Fixed overhead ($2.60 general company overhead, $1.65 depreciation, and, $0.90 supervision)
5.15
Total cost per drum
$
24.65
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 $175,500 per year.
Alternative 2:
Purchase the drums from an outside supplier at $18 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 ($58,500 per year) and direct materials cost per drum would
not be affected by the new equipment. The new equipment’s capacity would be
225,000 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 65,000 drums are needed each year.
(a) What will be the total relevant cost of 65,000 drums if they are manufactured
internally as compared to being purchased?
Total Relevant Cost(65000 drums):
(b.) What would be the per unit cost of each drum manufactured internally? (Round your answer to 2 decimal places.)
Per unit cost of drum:
(c) Which course of action would you recommend to the managing director?
a. Purchase from the outside supplier
b. Manufacture internally
OR
c. Indifferent between the two alternatives
2a-
What will be the total relevant cost of 195,000 drums if they are manufactured
internally?
Total relevant cost (195000 drums):
2b-
What would be the per unit cost of drums?
Per unit cost of drum:
2c-
What course of action would you recommend if 195,000 drums are needed each year?
Indifferent between the two alternatives
Manufacture Internally
Purchase from outside supplier
2d-
What will be the total relevant cost of 225,000 drums if they are
manufactured internally?
Total Relevant cost (225000 drums):
2e.
What would be the per unit cost of drums? (Round your answer to 2 decimal
places.)
Per unit cost of drum:
2f.
What course of action would you recommend if 225,000 drums are needed
each year?
manufacture internally
purchase from outside supplier
indifferent between the two alternatives
“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 $18 per drum, we would be paying $6.65 less than it costs us to
manufacture the drums in our own plant. Since we use 65,000 drums a year, that
would be an annual cost savings of $432,250.” Antilles Refining’s current cost to
manufacture one drum is given below (based on 65,000 drums per year):
Explanation / Answer
1a. Relevant cost for 65,000 drums = direct material+direct labor+variable overhead+rent+supervision cost
Now, direct labor and variable overhead will reduce by 30% each. Thus they will become 1-30% = 70% or 0.7. Thus, direct material+direct labor+variable overhead = 10.5+(7.5*0.7)+(1.5*0.7) = $16.80 per drum. Total for 65,000 drums = 16.8*65,000 = $1,092,000. Add: rental cost of $175,500 and supervision cost of $58,500. Total = $1,326,000
b. cost of making each drum internally = total relevant costs/number of drums = 1,326,000/65,000 = $20.40
c. cost of purchasing from outside supplier ($18)< manufacturing internally ($20.40). Hence drums should be purchased from outside supplier.
2a. relevant costs for 195,000 drums: direct material+direct labor+variable overhead = 10.5+(7.5*0.7)+(1.5*0.7) = $16.80 per drum. Total = 195,000*16.8 = $3,276,000
Add: Add: rental cost of $175,500 and supervision cost of $58,500. Total = $3,276,000+175500+58500 = $3,510,000
2b. cost per unit = $3,510,000/195,000 = $18 per drum
2c. cost of purchasing from outside supplier ($18) = manufacturing internally ($18). Hence indifferent.
2d. relevant cost for 225,000 drums = direct material+direct labor+variable overhead = 10.5+(7.5*0.7)+(1.5*0.7) = $16.80 per drum. Total = 225,000*16.8 = $3,780,000
Add: Add: rental cost of $175,500 and supervision cost of $58,500. Total = $3,780,000+$175,500+$58,500 = $4,014,000
2e. per unit cost = 4014000/225000 = $17.84
2f. cost of purchasing from outside supplier ($18) > manufacturing internally ($17.84). Hence we should manufacture internally.
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