“In my opinion, we ought to stop making our own drums and accept that outside su
ID: 2598292 • 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 $6.45 less than it costs us to manufacture the drums in our own plant. Since we use 60,000 drums a year, that would be an annual cost savings of $387,000.” Antilles Refining’s current cost to manufacture one drum is given below (based on 60,000 drums per year):
Direct materials
$
10.50
Direct labor
7.50
Variable overhead
1.50
Fixed overhead ($3.10 general company overhead, $1.75 depreciation, and, $1.10 supervision)
5.95
Total cost per drum
$
25.45
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 $198,000 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 ($66,000 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.
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 60,000 drums are needed each year.
a.
What will be the total relevant cost of 60,000 drums if they are manufactured internally as compared to being purchased?
Total relevant cost (60,000 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: ________
2a-1.
What will be the total relevant cost of 120,000 drums if they are manufactured internally?
Total relevant cost (120,000 drums):_______
2a-2.
What would be the per unit cost of drums?
Per unit cost of drum:______
2b-1.
What will be the total relevant cost of 150,000 drums if they are manufactured internally?
Total relevant cost (150000 drums):__________
2b-2.
What would be the per unit cost of drums? (Round your answer to 2 decimal places.)
Per unit Cost of Drum:_______
Direct materials
$
10.50
Direct labor
7.50
Variable overhead
1.50
Fixed overhead ($3.10 general company overhead, $1.75 depreciation, and, $1.10 supervision)
5.95
Total cost per drum
$
25.45
Explanation / Answer
Answer 1:
Analysis of the impact of make or buy drums (60000 drums)
The effect of buying drums from outside supplier is a saving of $132000.
(a) Total relevant cost of 60,000 drums if they are manufactured internally as compared to being purchased:
Total relevant cost (60,000 drums) = $ 1458000
(b) Per unit cost of each drum manufactured internally = $24.30
Answer 2a-1:
Total relevant cost of 120,000 drums if they are manufactured internally
Answer 2a-2:
Per unit cost of drums (120000 drums) = $20.55
Answer 2b-1:
Total relevant cost of 150,000 drums if they are manufactured internally
Answer 2b-2:
Per unit cost of drums (150000 drums) = $19.80
Per unit Make Buy Difference Direct Material 10.50 630000 0 -630000 Direct Labour 5.25 315000 0 -315000 Variable Manufacturing Overhead 1.05 63000 0 -63000 Supervision Cost 1.10 66000 0 -66000 General Company Overhead 3.10 186000 186000 0 Rent of equipment 3.30 198000 0 -198000 Cost of buying 19.00 1140000 1140000 Total 1458000 1326000 -132000Related Questions
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