Question

Make or Buy
Walsh Corporation currently makes the nylon mooring cover for its main product, a fiberglass boat designed for tournament bass fishing. The costs of producing the 2,000 covers needed each year follow:

Nylon fabric				$320,000
Wood battens				64,000
Brass fittings				32,000
Direct labor				128,000
Variable manufacturing overhead				96,000
Fixed manufacturing overhead				170,000

Calvin Company, a specialty fabricator of synthetic materials, can make the needed covers of comparable quality for $290 each, F.O.B. shipping point. Walsh would furnish its own trademark insignia at a unit cost of $20. Transportation in would be $15 per unit, paid by Walsh Corporation.

Walsh’s chief accountant has prepared a cost analysis that shows that only 30% of fixed overhead could be avoided if the covers are purchased. The covers have been made in a remote section of Walsh’s factory building, using equipment for which no alternate use is apparent in the foreseeable future.

a. Prepare a differential analysis showing whether or not you would recommend that the mooring covers be purchased from Calvin Company.

If appropriate, use a negative sign with your answer to represent a net disadvantage answer. Do not use negative signs with any other answers.

Make or Buy Differential Analysis
Cost to purchasecovers:		Answer
Costs avoided by purchasingcovers:
Direct materials	Answer
Direct labor	Answer
Variable manufacturing overhead	Answer
Fixed manufacturing overhead	Answer	Answer
Net advantage (disadvantage)to purchase alternative		Answer

b. Assuming that the production capacity released by purchasing the covers could be devoted to a subcontracting job for another company that netted a contribution margin of $64,000, what maximum purchase price could Walsh pay for the covers?

Round answer to two decimal places, if applicable.

$Answer

Answer 1

a) Make or Buy differential analysis
No of covers required	a		2000
Cost to purchase covers
Purchase cost	b=a*$290	$ 580,000.00
Trade mark cost	c=a*$20	$    40,000.00
Transportation cost	d=a*$15	$    30,000.00
Total purchase cost of covers	E=b+c+d		$ (650,000.00)
Savings due to purchase
Direct materials ($320000+64000+32000)	f	$ 416,000.00
Direct labour	g	$ 128,000.00
Variable manufacturing overhead	h	$    96,000.00
Fixed manufacturing overhead	i	$    51,000.00
Total Savings due to purchase	j=f+g+h+i		$    691,000.00
Net financial advantage/(disadvantage) due to purchase	k=e+j		$      41,000.00
It is advised to purchase the mooring covers from Calvin Company as it leads to financial advantage of $41,000 to the company.
b) If the released capacity is subcontracted to another company for contribution margin of $64,000, it will result into increase in the net financial advantyage from $41000 to $1,05,000. Therefore total savings due to purchase =$691000+64000= $7,55,000. Additional cost of trade mark & transportaion cost to be deducted from this total savings. Accordingly net savings =$755000-40000-30000=$685000/2000 covers= $342.5, which is the maximum purchase price that Wash can offer to Calvin for purchase of cover.

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