Freeman Electronics currently produces the shipping containers it uses to delive
ID: 2591083 • Letter: F
Question
Freeman Electronics currently produces the shipping containers it uses to deliver the electronics products it sells. The monthly cost of producing 9,400 containers follows. Unit-level materials $ 5,000 Unit-level labor 6,000 Unit-level overhead 3,400 Product-level costs* 7,800 Allocated facility-level costs 26,500 *One-third of these costs can be avoided by purchasing the containers. Baxi Container Company has offered to sell comparable containers to Freeman for $2.60 each. Required a-1. Calculate the total relevant cost. a-2. Should Freeman continue to make the containers? Yes No b-1. Freeman could lease the space it currently uses in the manufacturing process. If leasing would produce $12,600 per month, Calculate the total avoidable costs. b-2. Should Freeman continue to make the containers? Yes No
Explanation / Answer
Freeman Electronics
a-1. Determination of relevant cost of making:
Material cost $5,000
Direct labor cost $6,000
Overhead $3,400
Avoidable costs –
Product level costs $2,600 (1/3rd of $7,800 avoidable)
Total cost $17,000
Number of containers 9,400
Total relevant cost of Making the containers $17,000
Cost of purchasing the container $2.60
Cost of purchasing 9,400 containers $24,440
Excess cost of BUY $7,440
Note: The facility level cost of $26,500 is not a relevant cost, as the same is allocated cost and is unavoidable regardless of Make or Buy decision.
a-2. Yes, Freeman should continue to Make the containers.
Since, the cost to BUY is higher than cost to MAKE the container, Freeman Electronics should opt to MAKE the containers.
b-1. Analysis of Make or Buy options, assuming lease rent of $12,600 per month:
The lease of $12,600 would be the opportunity cost of making the containers, as Freeman would have to forego the opportunity of leasing the facility at $12,600 per month by continuing to make the containers.
Hence, lease rent is an opportunity cost, which is avoidable if the company opts to Buy the containers.
So, cost to make the containers is arrived at as follows,
Cost of Making 9,400 containers $17,000 (as calculated above in a-1)
Opportunity cost (lease) $12,600
Total relevant cost $29,600
Cos to Buy the containers $24,440
Excess of Making $5,160
b-2. No, Freeman should not continue to Make the containers.
Assuming leasing of facility, Freeman should opt to Buy the containers, as the cost to Buy is lower than cost to Make.
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