“In my opinion, we ought to stop making our own drums and accept that outside su
ID: 2598042 • 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 $18 per drum, we would be paying $6.65 less than it costs us to manufacture the drums in our own plant. Since we use 65,000 drums a year, that would be an annual cost savings of $432,250.” Antilles Refining’s current cost to manufacture one drum is given below (based on 65,000 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:
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 30%. The old equipment has no resale value. Supervision cost ($58,500 per year) and direct materials cost per drum would not be affected by the new equipment. The new equipment’s capacity would be 225,000 drums per year.
The company’s total general company overhead would be unaffected by this decision. (Round all intermediate calculations to 2 decimal places.)
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 65,000 drums are needed each year.
What will be the total relevant cost of 65,000 drums if they are manufactured internally as compared to being purchased?
What would be the per unit cost of each drum manufactured internally? (Round your answer to 2 decimal places.)
What will be the total relevant cost of 195,000 drums if they are manufactured internally?
What would be the per unit cost of drums?
What will be the total relevant cost of 225,000 drums if they are manufactured internally?
What would be the per unit cost of drums? (Round your answer to 2 decimal places.)
“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 $18 per drum, we would be paying $6.65 less than it costs us to manufacture the drums in our own plant. Since we use 65,000 drums a year, that would be an annual cost savings of $432,250.” Antilles Refining’s current cost to manufacture one drum is given below (based on 65,000 drums per year):
Explanation / Answer
1) Recommendations to managing director to make or buy drums:-
It is given that direct materials are $10.50, direct labor is $7.50, variable overhead is $1.50, fixed overhead is $5.15 (which includes $2.60 general company overhead, $1.65 depreciation, and $0.90 supervision), buying price $18 per drum, 65,000 drums required per year, rent for new equipment is $175,500 per year, if use new equipment reduce 30% in direct labor and variable overhead cost and new equipment capacity is 225,000 drums per year.
Equipmental rental per unit = $175,500/65,000 = $2.70 per drum
Hence, the company buying drum will gain $2.40 per drum ($156,000 for 65,000 drums). So buying decision is advisable. General overhead cost is irrelevant for decision because even if company buys or make drums, the cost will occur. Depreciation is a sunk cost which is not relevant to decision. Supervision cost is relevant because the cost will be avoided if buying drums.
a) Total Relevant cost for 65,000 drums will be ($20.40*65,000 drums) = $1,326,000
b) Per unit cost will be $20.40
c) As there is a gain of $2.40 per drum in purchasing the drum, the drum should be purchased.
2a) 1) Total Relevant cost for 195,000 drums = [($20.40-$2.70)*195,000]+$175,500
= $3,451,500+$175,500 = $3,627,000
2a) 2) Per unit cost of drums = Total relevant cost/No. of drums = $3,627,000/195,000 = $18.60
2a) 3) As there is a net gain of $0.60 per drum ($18.60-$18.00) in purchasing of drums, the drums should be purchased from outside supplier.
2b) 1) Total relevant cost of 225,000 drums = [($20.40-$2.70)*225,000]+$175,500
= $3,982,500+$175,500 = $4,158,000
2b) 2) Cost per drum = $4,158,000/225,000 = $18.48
2b) 3) There is a gain of $0.48 per drum ($18.48-$18) in purchasing the drums, therefore the company should purchase the drums from outside supplier.
Particulars Make Buy Outside Supplier's price $18.00 Direct materials $10.50 Direct Labor ($7.50*0.70) $5.25 Variable overhead cost ($1.50*0.70) $1.05 Supervision $0.90 Equipment rental $2.70 Total Cost $20.40 $18.00 Difference (20.40-18.00) $2.40Related Questions
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