John believes that annual operating income, before taxes, of $750,000 and a retu
ID: 2520362 • Letter: J
Question
John believes that annual operating income, before taxes, of $750,000 and a return on equity of thirty five percent would be sufficient to attract investors if the company goes public. Chan isn’t so sure. Currently, the company’s annual operating profits are well below $750,000 per year but the ROE is close to thirty five percent. John knows that if he can increase annual profits he can take the company public with Chan’s blessing. One option under consideration is to reduce the costs of manufacturing by buying a key component from an outside supplier instead of producing it in house.
The company needs approximately 40,000 rotary heads for the razors it manufacturers each year or more, depending on how many units are sold. The costs of producing the rotary heads in house is provided below:
Per Unit
Total
(40,000 Units)
Raw Materials
$1.25
$50,000
Direct Labor
$4.50
$180,000
Variable Mfg Overhead
$.75
$30,000
Fixed Manufacturing OH
$100,000
If the rotary heads are purchased instead of made by Blues Traveler Co. thirty percent of the fixed manufacturing overhead costs will be eliminated. In addition, if the rotary heads are purchased instead of manufactured it will free up space at the assembly plant in Asia and the idle factory space can be rented out to a third party for $44,300 per year.
11. Assume that the rotary heads can be purchased for $7.50 per unit. Should Blues Traveler make the rotary heads or purchase them from the outside supplier. How much is the savings by doing the cheapest alternative?
Per Unit
Total
(40,000 Units)
Raw Materials
$1.25
$50,000
Direct Labor
$4.50
$180,000
Variable Mfg Overhead
$.75
$30,000
Fixed Manufacturing OH
$100,000
Explanation / Answer
Differential analysis :
Blues traveler should buy the rotary heads because it savings of 34300.
Make Buy Direct material 50000 Direct labour 180000 Variable mfg overhead 30000 Fixed mfg overhead 30000 Opportunity cost 44300 Purchase cost (40000*7.5) 300000 Total 334300 300000Related Questions
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