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 $100,000 per year.

Alternative 2: Purchase carburetors from an outside supplier for $17.40 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	$	6.00
Direct labour		8.00
Variable overhead		3.20
Fixed overhead ($1.25 supervision, $1.80 depreciation,     and $4.00 general company overhead)		7.05
Total cost per unit	$	24.25

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 ($50,000 per year) and direct materials cost per unit would not be affected by the new equipment. The new equipment’s capacity would be 62,500 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?
	Manufacture internally Purchase from the outside supplier Indifferent between the two alternatives

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 50,000 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 50,000 assemblies are needed each year?
	Purchase from the outside supplier Indifferent between the two alternatives Manufacture internally

b-1.	What will be the total relevant cost of 62,500 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 62,500 assemblies are needed each year?
	Purchase from the outside supplier Indifferent between the two alternatives Manufacture internally

  

Answer 1

Solution 1a:

Computation of relevant cost of subassemblies if they are manufactured internally -Hondrich Company (40000 units)
Particulars	Amount
Direct Material (40000*$6)	$240,000.00
Direct Labor (40000*$6)	$240,000.00
Variable overhead (40000*$2.40)	$96,000.00
Rental cost of equipment	$100,000.00
Supervision cost	$50,000.00
Total Relevant Cost	$726,000.00

Solution 1b:

Per unit cost of the each subassembly manufactured internally = $726,000 / 40000 = $18.15

Solution 1c:

As manufacturing cost per unit is higher than buying cost, therefore carburetors should be purchase from the outside supplier

Solution 2-a1:

Computation of relevant cost of subassemblies if they are manufactured internally -Hondrich Company (50000 units)
Particulars	Amount
Direct Material (50000*$6)	$300,000.00
Direct Labor (50000*$6)	$300,000.00
Variable overhead (50000*$2.40)	$120,000.00
Rental cost of equipment	$100,000.00
Supervision cost	$50,000.00
Total Relevant Cost	$870,000.00

Solution 2-a2:

Per unit cost of the each subassembly manufactured internally = $870,000 / 50000 = $17.40

Solution 2-a3:

As manufacturing cost per unit is equal to the buying cost, therefore either of two alternative can be selected. Indifferent between the two alternatives

Solution 2-b1:

Computation of relevant cost of subassemblies if they are manufactured internally -Hondrich Company (62500 units)
Particulars	Amount
Direct Material (62500*$6)	$375,000.00
Direct Labor (62500*$6)	$375,000.00
Variable overhead (62500*$2.40)	$150,000.00
Rental cost of equipment	$100,000.00
Supervision cost	$50,000.00
Total Relevant Cost	$1,050,000.00

Solution 2-b2:

Per unit cost of the each subassembly manufactured internally = $1,050,000 / 62500 = $16.80

Solution 1c:

As manufacturing cost per unit is lesser than buying cost, therefore carburetors should be Manufacture internally