11-40 Make or buy, unknown level ofvolume. (A. Atkinson, adapted) Denver Engineering manufac-tures small engines that it sells to manufacturers who install themin products such as lawn mowers. The company currently manufacturesall the parts used in these engines but is considering a proposalfrom an external supplier who wishes to supply the starterassemblies used in these engines.
The starter assemblies are currently manufactured in Division 3of Denver Engineering. The costs relat- ing to the starterassemblies for the past 12 months were as follows:
Directmaterials $550,000
Variable direct manufacturing labor $300,000
Manufacturing overhead $800,000
Total $1,650,000
Over the past year, Division 3 manufactured 150,000 starterassemblies. The average cost for each starter assembly is $10($1,500,000 / 150,000).
Further analysis of manufacturing overhead revealed thefollowing information. Of the total manufac- turing overhead, only25% is considered variable. Of the fixed portion, $300,000 is anallocation of general overhead that will remain unchanged for thecompany as a whole if production of the starter assemblies isdiscontinued. A further $200,000 of the fixed overhead is avoidableif production of the starter assemblies is discontinued. Thebalance of the current fixed overhead, $100,000, is the divisionmanager’s salary. If Denver Engineering discontinues production ofthe starter assemblies, the manager of Division 3 will betransferred to Division 2 at the same salary. This move will allowthe company to save the $80,000 salary that would otherwise be paidto attract an outsider to this position.
- Tutwiler Electronics, a reliable supplier, has offeredto supply starter-assembly units at $8 per unit. Because this priceis less than the current average cost of $10 per unit, the vicepresident of manufacturing is eager to accept this offer. On thebasis of financial considerations alone, should Denver Engineeringaccept the outside offer? Show your calculations. (Hint:Production output in the coming year may be different fromproduction output in the past year.)
- How, if at all, would your response to requirement 1change if the company could use the vacated plant space for storageand, in so doing, avoid $100,000 of outside storage chargescurrently incurred? Why is this information relevant orirrelevant?
