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 $19 per drum, we would be paying $5.35 less than it costs us to manufacture the drums in our own plant. Since we use 60,000 drums a year, that would be an annual cost savings of $321,000.” Antilles Refining’s current cost to manufacture one drum is given below (based on 60,000 drums per year):

Direct materials	$	10.45
Direct labor		7.00
Variable overhead		1.50
Fixed overhead ($3.00 general company overhead, $1.70 depreciation, and, $0.70 supervision)		5.40
Total cost per drum	$	24.35

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 $168,000 per year.

Alternative 2: Purchase the drums from an outside supplier at $19 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 20%. The old equipment has no resale value. Supervision cost ($42,000 per year) and direct materials cost per drum would not be affected by the new equipment. The new equipment’s capacity would be 140,000 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. Assuming that 60,000 drums are needed each year, what is the financial advantage (disadvantage) of buying the drums from an outside supplier?

2. Assuming that 120,000 drums are needed each year, what is the financial advantage (disadvantage) of buying the drums from an outside supplier?

3. Assuming that 140,000 drums are needed each year, what is the financial advantage (disadvantage) of buying the drums from an outside supplier?

(For all requirements, enter any "disadvantages" as a negative value. Do not round intermediate calculations.)

Answer 1

Answer 1

Direct materials	10.45
Direct labor	5.60
Variable overhead	1.20
Total Relevant Variable cost	17.25
Variable Cost to Manufacture 60,000 drums	10,35,000
Equipment Rental	1,68,000
Supervision Cost	42,000
Total Cost of Mfg. drums (A)	12,45,000
Cost of Buying Drums per unit	19.00
Total Cost of Buying 60,000 Drums (B)	11,40,000
Net Financial advantage / (disadvantage) of buying the drums from an outside supplier	1,05,000

Answer 2

Direct materials	10.45
Direct labor	5.60
Variable overhead	1.20
Total Relevant Variable cost	17.25
Variable Cost to Manufacture 120,000 drums	20,70,000
Equipment Rental	1,68,000
Supervision Cost	42,000
Total Cost of Mfg. drums (A)	22,80,000
Cost of Buying Drums per unit	19.00
Total Cost of Buying 120,000 Drums (B)	22,80,000
Net Financial advantage / (disadvantage) of buying the drums from an outside supplier	-

Answer 3

Direct materials	10.45
Direct labor	5.60
Variable overhead	1.20
Total Relevant Variable cost	17.25
Variable Cost to Manufacture 140,000 drums	24,15,000
Equipment Rental	1,68,000
Supervision Cost	42,000
Total Cost of Mfg. drums (A)	26,25,000
Cost of Buying Drums per unit	19.00
Total Cost of Buying 120,000 Drums (B)	26,60,000
Net Financial advantage / (disadvantage) of buying the drums from an outside supplier	(35,000)