13 \"In my opinion, we ought to stop making our own drums and accept that outsid

Question

13 "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 $22 per drum, we would be paying $3.50 less than it costs us to manufacture the drums in our own plant. Since we use 95,000 drums a year, that would be an annual cost savings of $332,500." Antilles Refining's current cost to manufacture one drum is given below (based on 95,000 drums per year) 10.60 Direct materials Direct labor Variable overhead Fixed overhead ($2.70 general company 8.00 1.50 depreciation, and, $1.00 overhead, $1.70 supervision) 5.40 25.50 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 Rent new equipment and continue to make the drums. The Alternative 2 equipment would be rented for $285,000 per year Purchase the drums from an outside supplier at $22 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 20%. The old equipment has no resale value. Supervision cost ($95,000 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 95,000 drums are needed each year

Explanation / Answer

1. rent new equipment

fixed overhead

( $1 supervision , $3 rent )

depreciation is not considered because new equipment is rented and rent cost has been taken.

general company overhead will incurred in both alternative therefore they are also not considered.

2. purchase the drum @ $22 per drum.

total cost = 22* 95000 = $ 2090000

alternative 2 should be adopted , as this results in saving of $0.2 per drum and $ 19000 in total.

cost per unit total cost (for 95000 units) direct material 10.60 1007000 direct labour 8*80% = 6.4 608000 variable overhead 1.5*80% = 1.2 114000

fixed overhead

( $1 supervision , $3 rent )

4 380000 total cost $ 22.2 $ 2109000

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