Make-or-Buy, Traditional Analysis Morrill Company produces two different types o

Question

Make-or-Buy, Traditional Analysis

Morrill Company produces two different types of gauges: a density gauge and a thickness gauge. The segmented income statement for a typical quarter follows.

The density gauge uses a subassembly that is purchased from an external supplier for $25 per unit. Each quarter, 2,320 subassemblies are purchased. All units produced are sold, and there are no ending inventories of subassemblies. Morrill is considering making the subassembly rather than buying it. Unit-level variable manufacturing costs are as follows:

No significant non-unit-level costs are incurred.

Morrill is considering two alternatives to supply the productive capacity for the subassembly.

Lease the needed space and equipment at a cost of $31,320 per quarter for the space and $11,600 per quarter for a supervisor. There are no other fixed expenses.

Drop the thickness gauge. The equipment could be adapted with virtually no cost and the existing space utilized to produce the subassembly. The direct fixed expenses, including supervision, would be $44,080, $9,280 of which is depreciation on equipment. If the thickness gauge is dropped, sales of the density gauge will not be affected.

Required:

1. Should Morrill Company make or buy the subassembly?
Make the subassembly

If it makes the subassembly, which alternative should be chosen?
Drop the thickness gauge

Enter the relevant costs of each alternative.

Density
Gauge Thickness
Gauge
Total Sales $ 174,000 $ 92,800 $ 266,800 Less variable expenses 92,800 53,360 146,160   Contribution margin $ 81,200 $ 39,440 $ 120,640 Less direct fixed expenses* 23,200 44,080 67,280 Segment margin $ 58,000 $ (4,640) $ 53,360 Less common fixed expenses 34,800 Operating income $ 18,560 * Includes depreciation.

Explanation / Answer

Currently the company is buying the subassembly from outside at $25 per unit
Each Quarter 2320 subassemblies are used.
Variable mfr cost per unit for making subassembly : 2+3+2 = 7
From above it is advisable to make subassembly as it results is savings of $18 per unit in comparison of purchase.
Now the decision to be taken is to which alter native must be used.
Alternative 1 : Lease and make
Total cost of subassemblies = (2320 units * 7) + 31320 per quarter of lease and equipment + 11600 supervisor cost
= 16240 + 31320+11600 = $59160

Alternative 2: Buy
Total Cost = 2320 units * 25 = $58000

Alternative 3 : Drop Thickness gauge and Make:
Total Costs = (2320 units * 7) + 44080 direct fixed expenses - 9280 dep(Sunk)
= 51040

Hence Alternative 3 is better and to be selected and due to alternative 3 losses posted by thickness gauge are also eliminated. Hence this option is better.

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