“That old equipment for producing carburetors is worn out,” said Bill Seebach, p
ID: 2585265 • Letter: #
Question
“That old equipment for producing carburetors is worn out,” said Bill Seebach, president of Hondrich Company. “We need to make a decision quickly.” The company is trying to decide whether it should rent new equipment and continue to make its carburetors internally or whether it should discontinue production of its carburetors and purchase them from an outside supplier. The alternatives follow:
Hondrich Company’s costs per unit of producing the carburetors internally (with the old equipment) are given below. These costs are based on a current activity level of 35,000 units per year:
The new equipment would be more efficient and, according to the manufacturer, would reduce direct labour costs and variable overhead costs by 25%. Supervision cost ($70,000 per year) and direct materials cost per unit would not be affected by the new equipment. The new equipment’s capacity would be 50,000 carburetors per year.
The total general company overhead would be unaffected by this decision.
Seebach is unsure what the company should do and would like an analysis showing the unit costs and total costs for each of the two alternatives given above. Assume that 35,000 carburetors are needed each year.
What will be the total relevant cost of 35,000 subassemblies if they are manufactured internally as compared to being purchased?
What would be the per unit cost of the each subassembly manufactured internally? (Do not round intermediate calculations. Round your answer to 2 decimal places.)
Which course of action would you recommend to the president?
“That old equipment for producing carburetors is worn out,” said Bill Seebach, president of Hondrich Company. “We need to make a decision quickly.” The company is trying to decide whether it should rent new equipment and continue to make its carburetors internally or whether it should discontinue production of its carburetors and purchase them from an outside supplier. The alternatives follow:
Explanation / Answer
Step 1:An analysis showing the unit costs and total costs for each of the two alternatives:
Step 2:Calculation of total relevant cost of 35,000 subassemblies if they are manufactured internally as compared to being purchased
Relevant Cost= Variable cost of producing + Rent
=$493500 + $140000
=$633500
Step 3:Calculation of per unit cost of the each subassembly manufactured internally
As calculated above=$24.1 per Unit
Step 4: The course of action I would recommend to the president
Since per unit cost of manufacturing internally is less than per unit cost of purchase plus fixed overhead.It would be preferable to manufacture internally.
Sl No Particulars Alternative I Alternative II Manufacture Purchase 1 Direct Material $5.40 2 Direct Labour $7.50 3 Variable Overhead $1.20 5 Total Variable Cost $14.10 6 Purchase price per unit $19.35 7 Total No of Units 35000 35000 8 Variable cost of 35000 units $493500 $677250 9 Fixed Cost i) Rent of new Equipment $140000 ii) Supervision Cost $70000 $70000 iii) General Company Overhead $140000 $140000 10 Total Cost $843500 $887250 11 Per Unit Cost (Sl No 10/Sl No 7) $24.1 Per Unit $25.35 Per UnitRelated Questions
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