South Side manufacturing produces a product called A710, a major component of which is called R37....

South Side manufacturing produces a product called A710, a major component of which is called R37. Currently, the company purchases 4,000 units per year of R37 from a supplier at a cost of $ 90 per unit. The company is considering manufacturing R37 and has compiled the following data:

• This process would require the purchase of a special machine costing $160,000. This machine would be used for four years, at which time it would be sold for $10,000. The machine would be included with other assets in a class with a CCA rate of 20 percent.

At the end of the second year of operation the machine will require $14,000 upgrades. Upgrades of $15,000, and $ 16,000 will be needed at the end of years 3 and 4.

• Direct materials for the R37 would consist of 6 kilograms at a cost of $3.00 per kilogram.

• Direct labour would be three hours per unit of R37, with an average labour rate of $15 per hour (fringe benefit costs average 20 percent).

• Supervision of the production of R37 would be handled by a manager who is currently paid $50,000 per year. He would continue with his present duties as well as supervising the production of R37 (expected to occupy 20 percent of his time) and would be paid an additional $ 10,000 per year.

• Variable overhead costs to produce R37 are expected to be $4.00 per direct labour hour per unit.

• The main factory is rented to a customer for $100,000 per year for 5,000 square metres. The production of R37 should require an area of 1,500 square metres that of this area. The remaining area can still be rented for $ 60,000 per year.

• Other fixed overhead costs (all cash) would be applied at the rate of $6 per labour hour per unit. The fixed overhead would exist even if R37 is not produced

• The manufacture of R37 would require an investment in working capital at the beginning of the project of $40,000.

• The demand for R37 is expected to remain stable at 4,000 units per year during the four years.

• South Side weighted average cost of capital is 10 percent and the income tax rate is 30 percent.

Required:

Should the company continue to purchase outside or manufacture

internally R37? Show computations

Expert Solution

ekkarill92 answered 2 years ago

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