“In my opinion, we ought to stop making our own drums and accept that outside su
ID: 2585643 • 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 $21 per drum, we would be paying $6.25 less than it costs us to manufacture the drums in our own plant. Since we use 75,000 drums a year, that would be an annual cost savings of $468,750.” Antilles Refining’s current cost to manufacture one drum is given below (based on 75,000 drums per year):
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 $157,500 per year.
Alternative 2: Purchase the drums from an outside supplier at $21 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 25%. The old equipment has no resale value. Supervision cost ($52,500 per year) and direct materials cost per drum would not be affected by the new equipment. The new equipment’s capacity would be 105,000 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 75,000 drums are needed each year.
a. What will be the total relevant cost of 75,000 drums if they are manufactured internally as compared to being purchased?
b. What would be the per unit cost of each drum manufactured internally? (Round your answer to 2 decimal places.)
c. Which course of action would you recommend to the managing director?
2a-1. What will be the total relevant cost of 87,500 drums if they are manufactured internally?
2a-2. What would be the per unit cost of drums?
2 a-3. What course of action would you recommend if 87,500 drums are needed each year?
2b-1. What will be the total relevant cost of 105,000 drums if they are manufactured internally?
2b-2. What would be the per unit cost of drums? (Round your answer to 2 decimal places.)
2b-3. What course of action would you recommend if 105,000 drums are needed each year?
Direct materials $ 10.65 Direct labor 9.00 Variable overhead 1.60 Fixed overhead ($3.40 general company overhead, $1.90 depreciation, and, $0.70 supervision) 6.00 Total cost per drum $ 27.25Explanation / Answer
1). Total costs schedule Manufacture 60,000 drums Alternative 1 Cost Direct materials (75,000*10.65) $7,98,750 Direct labor [75,000*9(1-0.25)] $5,06,250 Variable Overhead [75,000*1.60(1-0.25)] $90,000 Fixed Overhead (75,000*6) $4,50,000 Equipment lease 1,57,500 Total cost $20,02,500 Alternative 2 Buy from outside supplier =75,000*$21 =$1,575,000 a). Total relevant cost schedule Direct materials (75,000*10.65) $7,98,750 Direct labor [75,000*9(1-0.25)] $5,06,250 Variable Overhead [75,000*1.60(1-0.25)] $90,000 Supervision (75,000*0.70) 52,500 Equipment lease 1,57,500 Total Relevant cost $16,05,000 b). Per unit cost = Total relevant cost/Total number of drums manufactured =$16,05,000/75,000 = $21.4 per drum c. Purchase from the outside supplier 2a-1 To produce 87,500 drums a year, Total relevant cost schedule Direct materials (87500*10.65) $9,31,875 Direct labor [87500*9(1-0.25)] $5,90,625 Variable Overhead [87500*1.60(1-0.25)] $1,05,000 Supervision (87500*0.70) 61,250 Equipment lease 1,57,500 Total Relevant cost $18,46,250 To buy, cost will be $21* 875000 = $18,375,000 2a-2 Per unit cost = Total relevant cost/Total number of drums manufactured =$1846250/87500 = $21.10 per drum 2a-3 Purchase from the outside supplier 2b-1 To produce 105000 drums a year, Total relevant cost schedule Direct materials (105000*10.65) $11,18,250 Direct labor [105000*9(1-0.25)] $7,08,750 Variable Overhead [105000*1.60(1-0.25)] $1,26,000 Supervision (105000*0.70) 73,500 Equipment lease 1,57,500 Total Relevant cost $21,84,000 To buy, cost will be $21* 105000 = 2205000 2b-2 Per unit cost = Total relevant cost/Total number of drums manufactured =$2184000/105000 = $20.8 per drum 2b-3 Manufacture internally
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