Question 1 (15 points) Frederick Machine Works (FMW) manufactures machine parts

Question

Question 1 (15 points) Frederick Machine Works (FMW) manufactures machine parts for aircraft auxiliary systems. The company is evaluating two alternatives regarding a compressor housing for the company’s best-selling product line. The alternatives are: · Purchase new equipment with a five-year life and no salvage value at a cost of $1,500,000. FMW uses straight-line depreciation and allocates that amount on a perunit- of production basis. · Purchase the housings from an outside vendor for $610 each with a five-year contract. FMW’s current cost to produce one compressor housing based on current and normal activity of 5,000 units per year follows: Direct Material $360 Direct Labor 165 Variable Overhead 90 Fixed Overhead* 85 TOTAL $700 *Fixed overhead includes $18 of production supervision cost, $17 depreciation unrelated to the new equipment, $10 rent/lease costs and $40 general company overhead. The new equipment will be more efficient than the old equipment and will reduce direct material costs by 5% and direct labor and variable overhead by 20%. Production supervision costs of $90,000 would be unchanged. The new equipment will have a capacity of 7,500 housings per year. FMW could lease the space occupied by the current housing production process to another firm for $60,000 per year if the company decided to buy from the outside vendor.

Prepare analyses including relevant unit costs for each alternative (make or buy) for three volumes of compressor housings:

a) 5,000

b) 6,000

c) 7,000

d) What qualitative factors should be included in this decision?

Explanation / Answer

New Equipment $1,500,000 Life 5 years Method SLM Depreciation on SLm for per unit production 1500000/7500 A $200 Totla Relevant cost for New Equipment Old New Units Units No. of units 5000 5000 6000 7000 Direct Material $360 $342.00 $342.00 $342.00 Direct Labour 165 132 $132.00 $132.00 Variable Ovehead 90 72 $72.00 $72.00 Depreciation on new machine 200 $200.00 $200.00 Rent cost 10 $10.00 $10.00 Total Relevant Cost to make $756.00 $756.00 $756.00 Fixed overhead These fixed cost will be same so not relevant Production Suprevision 18 Depreciation other than new 17 General Overhead 40 5000 6000 7000 Cost-Buy $610 per unit $3,050,000 $3,660,000 $4,270,000 Saving afrom lease $60,000 ($60,000) ($60,000) ($60,000) Total cost to buy $2,990,000 $3,600,000 $4,210,000 Relevant unit Cost to buy $598 $600 $601 It is better to buy Ans 2 The qualitatative factors can include that theproduct purchased from outside vendor is upto the compnany standard policy for that product The quailty of the product and management must be good of the vendor, the vendor must have goodwill and should not give sub standard products. How many employees job will be lost by this decision, what impact it will have on employees and the company Will the product will be delivered to the company on time by the vendors.

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