Make-or-Buy, Traditional Analysis Morrill Company produces two different types o
ID: 2559807 • Letter: M
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, 2,120 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 $28,620 per quarter for the space and $10,600 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 $40,280, $8,480 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?
If it makes the subassembly, which alternative should be chosen?
Enter the relevant costs of each alternative.
2. Suppose that dropping the thickness gauge will decrease sales of the density gauge by 10 percent. What decision should now be made?
3. Assume that dropping the thickness gauge decreases sales of the density gauge by 10 percent and that 2,968 subassemblies are required per quarter. As before, assume that there are no ending inventories of subassemblies and that all units produced are sold. Assume also that the per-unit sales price and variable costs are the same as in Requirement 1. Include the leasing alternative in your consideration. Now, what is the correct decision?
DensityGauge Thickness
Gauge
Total Sales $ 159,000 $ 84,800 $ 243,800 Less variable expenses 84,800 48,760 133,560 Contribution margin $ 74,200 $ 36,040 $ 110,240 Less direct fixed expenses* 21,200 40,280 61,480 Segment margin $ 53,000 $ (4,240) $ 48,760 Less common fixed expenses 31,800 Operating income $ 16,960 * Includes depreciation.
Explanation / Answer
Step 1:Analysis of Make or Buy Decision
Decision: Since the Total purchase price of buying from external parties is less than making cost.Therefore the company should buy the subassembly from external Parties.
Step 2:If the company makes the subassembly, which alternative should be chosen?
The relevant costs of each alternative
Decision:Since the relevant cost of Dropping thickness gauge and make is less therefore the company should drop thickness gauge and make
Step 3:Decision should be made if dropping the thickness gauge will decrease sales of the density gauge by 10 percent.
Decision:Since operating income is more than the current situation of the company therefore the company should continue to the decision that is Drop Thickness Gauge and Make
Step 4:Decision should be made assuming that dropping the thickness gauge decreases sales of the density gauge by 10 percent and that 2,968 subassemblies are required per quarter.
Decision:The company should drop the thickness gauge and make
Sl No Particulars Alternative I Alternative II Alternative III Lease and Make Buy Drop Thickness Gauge and Make 1 No of Subassembly 2120 2120 2120 2 Variable costs i) Direct Material $4240 $4240 ii) Direct Labour $6360 $6360 iii) Variable Overhead $4240 $4240 3 Total Variable Cost $14840 $14840 4 Fixed Cost i) Space $28620 ii) Supervision $10600 iii) Direct Fixed Expenses $40280 5 Total Fixed Cost $39220 $40280 6 Total Cost (3+5) $54060 $55120 7 Total Purchase price $53000Related Questions
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