“In my opinion, we ought to stop making our own drums and accept that outside su
ID: 2585321 • 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 $4.80 less than it costs us to manufacture the drums in our own plant. Since we use 70,000 drums a year, that would be an annual cost savings of $336,000.” Antilles Refining’s current cost to manufacture one drum is given below (based on 70,000 drums per year): Direct materials $ 10.60 Direct labor 5.00 Variable overhead 1.50 Fixed overhead ($3.60 general company overhead, $2.00 depreciation, and, $1.10 supervision) 6.70 Total cost per drum $ 23.80 ________________________________________ 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 $231,000 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 20%. The old equipment has no resale value. Supervision cost ($77,000 per year) and direct materials cost per drum would not be affected by the new equipment. The new equipment’s capacity would be 110,000 drums per year. The company’s total general company overhead would be unaffected by this decision. (Round all intermediate calculations to 2 decimal places.)
2b-1. What will be the total relevant cost of 110,000 drums if they are manufactured internally?
2b-2. What would be the per unit cost of drums? (Round your answer to 2 decimal places.)
Explanation / Answer
2b-1. Total relevant cost of 110000 drums manufactured internally: $803000
2b-2. Per unit cost of drums: $7.30
The direct materials cost and supervision costs would not be affected by the new equipment and are hence irrelevant. The general company overhead would also be unaffected by the decision and hence is irrelevant. Depreciation on the old equipment is a sunk cost and hence also irrelevant.
Per unit Total for 110000 drums $ Rent of new equipment 2.10 231000 Direct labor ($5 - 20% of $5) 4.00 440000 Variable overhead ($1.50 - 20% of $1.50) 1.20 132000 Total costs $ 7.30 803000Related Questions
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