1) Make or Buy Terry Inc. manufactures machine parts for aircraft engines. CEO B
ID: 2379463 • Letter: 1
Question
1) Make or Buy
Terry Inc. manufactures machine parts for aircraft engines. CEO Bucky Walters is considering an offer from a subcontractor to provide 2,000 units of product OP89 for $120,000. If Terry does not purchase these parts from the subcontractor, it must continue to produce them in-house with these costs:
Cost per unit
Direct Materials ...................$28
Direct labor...........................18
Variable overhead.................16
Allocated fixed overhead...........4
Required: Should Terry, Inc. accept the offer from the subcontractor? Why or why not? Include a consideration of financial and nonfinancial factors.
2) Disposal of Assets: A company has an inventory of 2,000 different parts for a line of cars that has been discontinued. The net book value (NBV) of this inventory is $50,000. The parts can be either remachined at a total additional cost of $25,000 and then sold for $30,000 or sold as-is for $2,500.
Required: What should it do? Include a consideration of both financial and nonfinancial factors.
3) Replacement of an Asset: An uninsured boat costing $90,000 was wrecked the first day it was used. It can be either sold as-is for $9,000 cash and replaced with a similar boat costing $92,000 or rebuilt for $75,000 and be brand new as far as operating characteristics and looks are concerned.
Required: What should be done? Include a consideration of both financial and nonfinancial factors.
Explanation / Answer
1. The relevant costs to be considered in the "make" decision is direct materials, direct labor and variable overhead. The allocated fixed overhead needs to be ignored as it is an allocated cost and will be incurred whether or not Terry makes this particular part.
So total cost = 28+18+16 = 62
Cost of making the parts inhouse = 62*2000 units = 124,000
On a purely financial note, Terry should buy these parts from the subcontractor as it ends up being cheaper (120,000 vs 124,000). However, Bucky, being the CEO, should consider non-financial factors also. For example, this buying the parts might mean the labor working on the units so far may need to be shifted to other divisions or if that's not possible, laid off. Either of these will mean some amount of costs and/or reputation harm and/or management bandwidth being spent on dealing with this.
Another factor that Bucky should consider is the quality of the units being procured. Inhouse manufacturing will let them have good quality control, while procured units may not necessarily have the same quality control.
2. If these are re-machined, net profit = incremental profit - incremental cost = 30,000-25,000 = 5,000
If these are sold as-is, net profit = 2,500
On a purely financial note, the company should re-machine the parts and then sell them. Non-financial factor to be considered is the time taken to re-machine - if this takes too much time, then there is a cost to carrying the inventory, and also the company may prefer selling the parts now and getting cash rightaway to take care of liquidity. Another factor to be considered is current spare capacity in the plant - if there is lot of spare capacity, it may be worthwhile to re-machine, but if there is little spare capacity, re-machining may take up scarce resources which are better spent on making other crucial parts.
3. Cost for selling as-is and then replacing = 92,000-9,000 = 83,000
Cost for re-building = 75,000
On a purely financial note, the boat should be re-built as it is cheaper by 8,000. On a non-financial note, the owner may be superstitious about the fact that a brand new boat was wrecked the very first day and may not want to re-build the boat, instead preferring to sell it off and buying a new boat instead.
Hope this helped ! Let me know in case of any queries.
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