\"In my opinion, we ought to stop making our own drums and accept that outside s
ID: 2559275 • 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 $17 per drum, we would be paying $6.85 less than it costs us to manufacture the drums in our own plant. Since we use 50,000 drums a year, that would be an annual cost savings of $342,500." Antilles Refining's current cost to manufacture one drum is given below (based on 50,000 drums per year) Direct materials Direct labor Variable overhead Fixed overhead($2.90 general $10.40 6.50 1.50 company overhead, $1.65 depreciation, and, $0.90 supervision) 5.45 Total cost per drum $23.85 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 $135,000 per year Alternative 2: Purchase the drums from an outside supplier at $17 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 40%. The old equipment has no resale value. Supervision cost ($45,000 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 2Explanation / Answer
***General overhead cost is irrelevant as it is unaffected.
50000Drums 100000Drums 125000drums cost of manufacturing Direct material 10.4*50000=520000 10.4*100000=1040000 1300000 Direct labor 6.5(1-.40)=3.9 3.9*50000=195000 390000 487500 variable overhead 1.5(1-.40)=.9 .9*50000=45000 90000 112500 Rental cost 135000 135000 135000 supervision 45000 45000 45000 Total cost to make 940000 1700000 2080000 cost of purchase 17*50000=850000 17*100000=1700000 17*125000=2125000 Financial advantage /(disadvantage) 90000 [940000-850000] 0 45000 [2125000-2080000]Related Questions
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