“In my opinion, we ought to stop making our own drums and acceptthat outside supplier’s offer,” said Wim Niewindt, managingdirector of Antilles Refining, N.V., of Aruba. “At a price of $19per drum, we would be paying $5.35 less than it costs us tomanufacture the drums in our own plant. Since we use 60,000 drums ayear, that would be an annual cost savings of $321,000.” AntillesRefining’s current cost to manufacture one drum is given below(based on 60,000 drums per year):
| | |
| Direct materials | $ | 10.45 |
| Direct labor | | 7.00 |
| Variable overhead | | 1.50 |
| Fixed overhead ($3.00 general company overhead, $1.70 depreciation, and, $0.70 supervision) | | 5.40 |
| Total cost per drum | $ | 24.35 |
|
A decision about whether to make or buy the drums is especiallyimportant at this time because the equipment being used to make thedrums is completely worn out and must be replaced. The choicesfacing the company are:
Alternative 1: Rent new equipment and continue to makethe drums. The equipment would be rented for $168,000 per year.
Alternative 2: Purchase the drums from an outsidesupplier at $19 per drum.
The new equipment would be more efficient than the equipmentthat Antilles Refining has been using and, according to themanufacturer, would reduce direct labor and variable overhead costsby 20%. The old equipment has no resale value. Supervision cost($42,000 per year) and direct materials cost per drum would not beaffected by the new equipment. The new equipment’s capacity wouldbe 140,000 drums per year.
The company’s total general company overhead would be unaffectedby this decision. (Round all intermediate calculations to 2decimal places.)
Required:
1. To assist the managing director in making a decision, preparean analysis showing the total cost and the cost per drum for eachof the two alternatives given above. Assume that 60,000 drums areneeded each year.
a. What will be the total relevant cost of 60,000 drums if theyare manufactured internally as compared to being purchased?
b. What would be the per unit cost of each drum manufacturedinternally? (Round your answer to 2 decimalplaces.)
c. Which course of action would you recommend to the managingdirector?
| Purchase from the outside supplier |
| Manufacture internally |
| Indifferent between the two alternatives |
2a-1. What will be the total relevant cost of 120,000 drums ifthey are manufactured internally?
2a-2. What would be the per unit cost of drums?
2 a-3. What course of action would you recommend if 120,000drums 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 140,000 drums ifthey are manufactured internally?
2b-2. What would be the per unit cost of drums? (Roundyour answer to 2 decimal places.)
2b-3. What course of action would you recommend if 140,000 drumsare needed each year?
| Manufacture internally |
| Purchase from the outside supplier |
| Indifferent between the two alternatives |
