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 $21 per drum, we would be paying $4.70 less than it costs us to manufacture the drums in our own plant. Since we use 70,000 drums a year, that would be an annual cost savings of $329,000.” Antilles Refining’s current cost to manufacture one drum is given below (based on 70,000 drums per year): Direct materials $ 10.50 Direct labor 7.50 Variable overhead 1.50 Fixed overhead ($3.10 general company overhead, $1.90 depreciation, and, $1.20 supervision) 6.20 Total cost per drum $ 25.70 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 $252,000 per year. Alternative 2: Purchase the drums from an outside supplier at $21 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 30%. The old equipment has no resale value. Supervision cost ($84,000 per year) and direct materials cost per drum would not be affected by the new equipment. The new equipment’s capacity would be 105,000 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 70,000 drums are needed each year, what is the financial advantage (disadvantage) of buying the drums from an outside supplier? 2. Assuming that 80,000 drums are needed each year, what is the financial advantage (disadvantage) of buying the drums from an outside supplier? 3. Assuming that 105,000 drums are needed each year, what is the financial advantage (disadvantage) of buying the drums from an outside supplier?

Answer 1

computation of buy or makr decision when 70000 units are produced

particulars	make	buy
buying price		21
direct material	10.5
direct labour(7.5*70%)	5.25
variable overhaeds(1.5*70%)	1.05
fixed overads
rent 252000/70000 units	3.6
supervision (84000/70000units)	1.2
total	21.6	21
difference is (21.6-21=.6) or savings in buying		.6

if we want 70000units there will be savings of 42000(0.6*70000) so it is better to buy from outside for 21

note general overheads is not considered in making a decision because it does not effect the decision of buy or make

if we produce 80000 units then

particulars	make	buy
buying price		21
direct material	10.5
direct labour(7.5*70%)	5.25
variable overhaeds(1.5*70%)	1.05
fixed overads
rent 252000/80000 units	3.15
supervision (84000/80000units)	1.05
total	21	21
difference is (21-21=.0) or savings in buying		0

if we neeed 80000 units then both will give the same cost

particulars	make	buy
buying price		21
direct material	10.5
direct labour(7.5*70%)	5.25
variable overhaeds(1.5*70%)	1.05
fixed overads
rent 252000/105000 units	2.4
supervision (84000/105000units)	.8
total	20	21
difference is (21.-20=1) or savings in buying	1

if we need 105000 units it is better to make the units becaues ther will be a savings of $1 for each unit so total savings will be 105000*1=105000