Question

“That old equipment for producing carburetors is worn out,” said Bill Seebach, president of Hondrich Company. “We need to make a decision quickly.” The company is trying to decide whether it should rent new equipment and continue to make its carburetors internally or whether it should discontinue production of its carburetors and purchase them from an outside supplier. The alternatives follow:

     Alternative 1: Rent new equipment for producing the carburetors for $92,000 per year.
     Alternative 2: Purchase carburetors from an outside supplier for $18.80 each.

     Hondrich Company’s costs per unit of producing the carburetors internally (with the old equipment) are given below. These costs are based on a current activity level of 40,000 units per year:

Direct materials	$	5.90
Direct labour		10.00
Variable overhead		3.20
Fixed overhead ($1.15 supervision, $1.90 depreciation,     and $5.00 general company overhead)		8.05
Total cost per unit	$	27.15

     The new equipment would be more efficient and, according to the manufacturer, would reduce direct labour costs and variable overhead costs by 25%. Supervision cost ($46,000 per year) and direct materials cost per unit would not be affected by the new equipment. The new equipment’s capacity would be 50,000 carburetors per year.

     The total general company overhead would be unaffected by this decision.

Required:
1. Seebach is unsure what the company should do and would like an analysis showing the unit costs and total costs for each of the two alternatives given above. Assume that 40,000 carburetors are needed each year.

a. What will be the total relevant cost of 40,000 subassemblies if they are manufactured internally as compared to being purchased?

b. What would be the per unit cost of the each subassembly manufactured internally? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

c. Which course of action would you recommend to the president?

• Indifferent between the two alternatives

• Purchase from the outside supplier

• Manufacture internally

2. Seebach is unsure what the company should do and would like an analysis showing the unit costs and total costs for each of the two alternatives given above.

a-1. What will be the total relevant cost of 46,000 subassemblies if they are manufactured internally?

a-2. What would be the per unit cost of subassembly? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

a-3. Which course of action would you recommend if 46,000 assemblies are needed each year?

• Manufacture internally

• Purchase from the outside supplier

• Indifferent between the two alternatives

b-1. What will be the total relevant cost of 50,000 subassemblies if they are manufactured internally?

b-2. What would be the per unit cost of subassembly? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

b-3. Which course of action would you recommend if 50,000 assemblies are needed each year?

• Indifferent between the two alternatives

• Manufacture internally

• Purchase from the outside supplier

Answer 1

1)

	Alternative 1		Alternative 2
	Make		Buy
	Per unit	Total cost	Per unit	Total cost
Direct materials	$5.90	(40000*$5.90)= $236000	-	-
Direct labor	7.50	(40000*$7.50)= 300000	-	-
Variable overhead	2.40	(40000*$2.40)= 96000	-	-
Supervision cost	1.15	$46000	-	-
Rent on new equipment	2.30	$92000	-	-
Purchase price	-	-	$18.80	(40000*$18.80)= $752000
Total relevant costs	$19.25	$770000	$18.80	$752000

New direct labor per unit= $10.00-25%*10.00= $7.50

New variable overhead= $3.20-25%*3.20= $2.40

Supervision cost per unit= $46000/40000= $1.15

Rent on new equipment= $92000/40000= $2.30

a) Total relevant cost (40000 subassemblies)= $770000

b) Per unit cost of subassembly= $19.25

c) President should buy the subassembly from the outside supplier as the total relevant cost of buy is less than the total relevant cost of making the subassembly.

So, the option is B) President should Purchase from the outside supplier.

2-a)

	Alternative 1		Alternative 2
	Make		Buy
	Per unit	Total cost	Per unit	Total cost
Direct materials	$5.90	(46000*$5.90)= $271400	-	-
Direct labor	7.50	(46000*$7.50)= 345000	-	-
Variable overhead	2.40	(46000*$2.40)= 110400	-	-
Supervision cost	1.00	$46000	-	-
Rent on new equipment	2.00	$92000	-	-
Purchase price	-	-	$18.80	(46000*$18.80)= $864800
Total relevant costs	$18.80	$864800	$18.80	$864800

New direct labor per unit= $10.00-25%*10.00= $7.50

New variable overhead= $3.20-25%*3.20= $2.40

Supervision cost per unit= $46000/46000= $1.00

Rent on new equipment= $92000/46000= $2.00

a-1) Total relevant cost (46000 subassemblies)= $864800

a-2) Per unit cost of subassembly= $18.80

a-3) President is indifferent between the two alternative as the relevant cost of both making and purchasing the subassembly is equal.

So, the option is C) President is indifferent between the two alternative

b)

	Alternative 1		Alternative 2
	Make		Buy
	Per unit	Total cost	Per unit	Total cost
Direct materials	$5.90	(50000*$5.90)= $295000	-	-
Direct labor	7.50	(50000*$7.50)= 375000	-	-
Variable overhead	2.40	(50000*$2.40)= 120000	-	-
Supervision cost	0.92	$46000	-	-
Rent on new equipment	1.84	$92000	-	-
Purchase price		-	$18.80	(50000*$18.80)= $940000
Total relevant costs	$18.56	$928000	$18.80	$940000

New direct labor per unit= $10.00-25%*10.00= $7.50

New variable overhead= $3.20-25%*3.20= $2.40

Supervision cost per unit= $46000/50000= $0.92

Rent on new equipment= $92000/50000= $1.84

b-1) Total relevant cost (50000 subassemblies)= $928000

b-2) Per unit cost of subassembly= $18.56

b-3) President should make the subassembly as the total relevant cost of making the subassembly is less than the total relevant cost of buying from outside supplier.

So, the option is B) Manufacture internally