\"In my opinion, we ought to stop making our own drums and accept that outside s
ID: 2527788 • 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 $20 per drum, we would be paying $4.25 less than it costs us to manufacture the drums in our own plant. Since we use 75,000 drums a year, that would be an annual cost savings of $318,750." Antilles Refining's current cost to manufacture one drum is given below (based on 75,000 drums per year): Direct materials Direct labor Variable overhead Fixed overhead ($2.80 general company overhead, $1.75 $ 11.10 6.00 1.60 depreciation, and, $1.00 supervision) 5.55 S 24.25 Total cost per drum 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 $225,000 per year Alternative 2: Purchase the drums from an outside supplier at $20 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 25%. The old equipment has no resale value. Supervision cost ($75,000 per year) and direct materials cost per drum would not be affected by the new equipment. The new equipment's capacity would be 125,000 drums per year The company's total general company overhead would be unaffected by this decision. (Round all intermediate calculations to 2 decimal places.) 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 75,000 drums are needed each year a. What will be the total relevant cost of 75,000 drums if they are manufactured internally as compared to being purchased? Total relevant cost (75,000 drums)Explanation / Answer
Cost per unit of drum if made internally
Direct material = 11.10
Direct labour = 4.50
Variable overhead = 1.20
Total Variable cost per unit = 16.80
Relevant fixed Cost = 75000
Relevant fixed cost of Rent = 225000
Answer to Q1
a) Relevant cost if made internally = 75000*16.80 + 75000 + 225000
= 15,60,000
b) Cost per unit = 15,60,000/75000
= 20.80
c) Should purchase from outside supplier
(Total cost of drums if purchased from Outside supplier = 75000* 20 = 15,00,000 is less as compared to Cost of making them internally i.e. 15,60,000)
Answer to Question - 2(a)
1. Relevant cost if made internally = 93750*16.80 + 75000 + 225000
= 1875000
2. Cost per unit = 1875000/93750
= 20.00
3. Should be indifferent
(Total cost of drums if purchased from Outside supplier = 93750* 20 = 18,75,000 is equal as compared to Cost of making them internally i.e. 18,75,000)
Answer to Question - 2(b)
a) Relevant cost if made internally = 125000*16.80 + 75000 + 225000
= 24,00,000
b) Cost per unit = 2400000/125000
= 19.20
c) Should make it internally
(Total cost of drums if purchased from Outside supplier = 125000* 20 = 25,00,000 is higher as compared to Cost of making them internally i.e. 24,00,000)
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