Question

1.The Winery Company (WC) manufactures wine coolers. WC manufactures two types of coolers: Regular and Premium. The Premium wine cooler uses a thermoelectric system instead of a compressor-powered cooling used in the Regular cooler. The thermoelectric system reduces the vibrations of the cooler, which may disturb the delicate sediments in fine wine. WC produces the compressor powered cooler, but purchases the thermoelectric system from Thermo, Inc for $50 per unit. Currently, WC produces and sells 1,000 units of each. The Premium cooler requires a special machine to install the thermoelectric system, which is operating at capacity.

The data for the two production units is given below.

	Regular	Premium
Raw Materials	$70	$150 (includes $50 for thermoelectric system)
Labor	5 hrs @ $10	8 hrs @ $10
Variable Overhead	$4 per DLH	$3 per DLH
Fixed Overhead	$5 per DLH	$4 per DLH
Market Price	$200	$300

WC is considering whether to rent a plant for $10,000 per year to produce the 1,000 units of the thermoelectric systems instead of purchasing them. The budgeted costs per unit for 1,000 units (not including rent) are as follows:

Thermo. System
Raw Materials	$10
Direct Labor	1 hr @ $10
Variable Overhead	$8 per DLH
Fixed Overhead	$7 per DLH
Capacity	2000 units

WC would then have to ship the thermoelectric system to its cooler plant at $6 per unit.

Required:

1.Should the company continue to buy the thermoelectric system from Thermo Inc.?

2. WC is considering renting an additional machine ($5,000 annual rent) that can install the thermoelectric system in the Premium coolers. The marketing department believes it can sell an additional 500 units, but the market price for Premium Coolers will drop to 280 per unit. Should WC rent the additional machine? (Assume that all other costs per unit are the same. Also, answer this question without changing your answer to question 1).

Answer 1

Answer 1:

No

The company should DISCONTINUE buying from Thermo Inc. Instead, it should make the thermoelectric system as the cost is lower.

Calculation:

Statement of Comparative Cost
Buy the parts	Amount	Make the parts	Amount
Purchase Cost	$ 50,000	Direct material	$ 10,000
		Direct Labor	$ 10,000
		Variable Manufacturing overheads	$   8,000
		Rent	$ 10,000
Total cost	$ 50,000	Total cost	$ 38,000

Answer 2:

WC should NOT rent the additional machinery because it results in an incremental loss of $ 12,000.

Calculation:

Annual rent of machine	$   (5,000.00)
Increased contribution [280-(150+80+24)*500]	$   13,000.00
Contribution lost	$ (20,000.00)
Total	$ (12,000.00)

In case of any doubt, please feel free to comment.