Question

Eaton Corporation, based in Cleveland, is a global manufacturer of highly engineered products that serve industrial vehicle, construction, commercial, aerospace, and semiconductor markets. It frequently subcontracts work to other manufacturers, depending on whether Eaton’s facilities are fully occupied. Suppose Eaton is about to make some final decisions regarding the use of its manufacturing facilities for the coming year.

The following are the costs of making part ML7X, a key component of an emissions control system:

                                                                                                         Total Cost for

                                                                                                         50,000 Units                   Cost per Unit                                                            Direct material                                 $   400,000                              $ 8

                        Direct labor                                            300,000                               6

                        Variable factory overhead                      150,000                               3

                        Fixed factory overhead                           300,000                                 6

                        Total manufacturing costs                  $1,150,000                            $23

Another manufacturer has offered to sell the same part to Eaton for $20 each. The fixed overhead consists of depreciation, property taxes, insurance, and supervisory salaries. All the fixed overhead would continue if Eaton bought the component except that the cost of $100,000 pertaining to some supervisory and custodial personnel could be avoided.

                        Required

Assume that the capacity now used to make parts will become idle if the parts are purchased. Should Eaton buy or make the parts? Show computations.

Assume that capacity now used to make parts will either (a) be rented to a nearby manufacturer for $65,000 for the year or (b) be used to make oil filters that will yield a profit contribution of $200,000. Should Eaton buy or make part ML7X? Show computations.

Answer 1

A)		50000 units
	Particulars	Make	Buy
	TOTAL COST TO BE INCURRED
	direct material	$                                     4,00,000.00
	Direct labor	$                                     3,00,000.00
	Variable factory overhead	$                                     1,50,000.00
	Fixed factory overhead	$                                     3,00,000.00	$       2,00,000.00
	purchase price (50000*20)		$     10,00,000.00
	total manufacturing costs	$                                  11,50,000.00	$     12,00,000.00
	saving in making option =	1200000-1150000 = $50000
	Since kn make option has cost saving $50000
	EATON SHOULD MAKE THE PARTS
B)	used of idle capacity
	option	Earning
	rent to a near by manufacturer	$65000
	Make oil filters	$200000
	the idle capacity will be used in the option that will provide maximum
	earning therefore the idle capacity will be used in making oil filters
	contribution to be lost in make option = $200000
	50000 units
	Particulars	Make	buy
	Direct material	$                                     4,00,000.00
	Direct labor	$                                     3,00,000.00
	variable factory overhead	$                                     1,50,000.00
	Fixed factory overhead	$                                     3,00,000.00	$       2,00,000.00
	purchase price		$     10,00,000.00
	total manufacturing cost	$                                  11,50,000.00	$     12,00,000.00
	contribution to be lost	$                                     2,00,000.00	$                          -
	total relevent cost	$                                  13,50,000.00	$     12,00,000.00
	Saving in buy option = 1350000-1200000 = $ 150000
	buy option has cost saving of $ 150000
	Eaton must BUY the parts