\"In my opinion, we ought to stop making our own drums and accept that outside s
ID: 2434655 • 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 18 florins per drum, we would be paying 5 florins less than it costs us to manufacture the drums in our own plant. (The currency in Aruba is the florin, denoted below by fl.) Because we use 60,000 drums a year, that would be an annual cost savings of 300,000 florins." Antilles Refining's present cost to manufacture one drum is given below(based on 60,000 drums per year): .Direct materials .fl10.35
Direct labor .6.00
Variable overhead .1.50
Fixed overhead (fI2.80 general company overhead, fl1.60 depreciation and, f10.75 supervision) .5.15
Total cost per drum .f123.00
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 ft135,000 per year.
Alternative 2: Purchase the drums from an outside supplier at fi18 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 (fl45,000 per year) and direct materials cost per drum would not be affected by the new equipment. The new equipment's capacity would be 90,000 drums per year.
The company's total general company overhead would be unaffected by this decision.
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. Which course of action would you recommend to the managing director?
2. Would your recommendation in (1) above be the same if the company's needs were: (a) 75,000 drums per year or (b) 90,000 drums per year? Show computations to support your answer, with costs presented on both a total and a per unit basis.
3. What other factors would you recommend that the company consider before making a decision?
"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 18 florins per drum, we would be paying 5 florins less than it costs us to manufacture the drums in our own plant. (The currency in Aruba is the florin, denoted below by fl.) Because we use 60,000 drums a year, that would be an annual cost savings of 300,000 florins." Antilles Refining's present cost to manufacture one drum is given below(based on 60,000 drums per year): .
Direct materials .fl10.35
Direct labor .6.00
Variable overhead .1.50
Fixed overhead (fI2.80 general company overhead, fl1.60 depreciation and, f10.75 supervision) .5.15
Total cost per drum .f123.00
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 ft135,000 per year.
Alternative 2: Purchase the drums from an outside supplier at fi18 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 (fl45,000 per year) and direct materials cost per drum would not be affected by the new equipment. The new equipment's capacity would be 90,000 drums per year.
The company's total general company overhead would be unaffected by this decision.
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. Which course of action would you recommend to the managing director?
2. Would your recommendation in (1) above be the same if the company's needs were: (a) 75,000 drums per year or (b) 90,000 drums per year? Show computations to support your answer, with costs presented on both a total and a per unit basis.
3. What other factors would you recommend that the company consider before making a decision?
Explanation / Answer
1. The cost of supervision is relevant to the decision because this cost can be avoided by buying the drums. 2. A. The company would be indifferent between the two alternatives if 75,000 drums were needed each year. Differential Cost Per Drum Total Differential Cost-75,000 Drums Make Buy Make Buy Outside supplier’s price fl18.00 fl1,350,000 Direct materials fl10.35 fl776,250 Direct labor 4.2 315,000 Variable overhead 1.05 78,750 Supervision 0.6 45,000 Equipment rental 1.80 135,000 Total cost fl18.00 fl18.00 fl1,350,000 fl1,350,000 b. The company should rent the new equipment and make the drums if 90,000 units per year are needed. Differential Costs Per Drum Total Differential Cost-90,000 Drums Make Buy Make Buy Outside supplier’s price fl18.00 fl1,620,000 Direct materials fl10.35 fl931,500 Direct labor 4.2 378,000 Variable overhead 1.05 94,500 Supervision 0.5 45,000 Equipment rental 1.50 135,000 Total cost fl17.60 fl18.00 fl1,584,000 fl1,620,000 3. Other factors that the company should consider include: a. Will volume in future years increase, or will it remain constant at 60,000 units per year? b. Can quality control be maintained if the drums are purchased from the outside supplier? c. Will costs for materials and labor increase in future years? d. Will the outside supplier dependably meet shipping schedules? e. Can the company begin making the drums again if the supplier proves to be undependable? Are there alternative suppliers? f. What is the labor outlook in the supplier’s industry g. If the outside supplier’s offer is accepted and the need for drums increases in future years, will the supplier have the added capacity to provide more than 60,000 drums per year? h. Will the rental cost of the equipment change in the future?
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