Question

Make-or-Buy, Traditional Analysis

Morrill Company produces two different types of gauges: a density gauge and a thickness gauge. The segmented income statement for a typical quarter follows.

	Density Gauge		Thickness Gauge		Total
Sales	$	187,500	$	100,000	$	287,500
Less variable expenses		100,000		57,500		157,500
Contribution margin	$	87,500	$	42,500	$	130,000
Less direct fixed expenses*		25,000		47,500		72,500
Segment margin	$	62,500	$	(5,000)	$	57,500
Less common fixed expenses						37,500
Operating income					$	20,000
* Includes depreciation.

The density gauge uses a subassembly that is purchased from an external supplier for $25 per unit. Each quarter, 2,500 subassemblies are purchased. All units produced are sold, and there are no ending inventories of subassemblies. Morrill is considering making the subassembly rather than buying it. Unit-level variable manufacturing costs are as follows:

Direct materials	$2
Direct labor	3
Variable overhead	2

No significant non-unit-level costs are incurred.

Morrill is considering two alternatives to supply the productive capacity for the subassembly.

1. Lease the needed space and equipment at a cost of $33,750 per quarter for the space and $12,500 per quarter for a supervisor. There are no other fixed expenses.
2. Drop the thickness gauge. The equipment could be adapted with virtually no cost and the existing space utilized to produce the subassembly. The direct fixed expenses, including supervision, would be $47,500, $10,000 of which is depreciation on equipment. If the thickness gauge is dropped, sales of the density gauge will not be affected.

Required:

1. Should Morrill Company make or buy the subassembly?
Make the subassembly

If it makes the subassembly, which alternative should be chosen?
Drop the thickness gauge

Enter the relevant costs of each alternative.

	Lease and Make	Buy	Drop Thickness Gauge and Make
Total relevant costs	$	$	$

Answer 1

answer
Particular	Lease and make	Buy
Purchase cost	$0	62500
		(2500*25)
Variable manfacturing cost	17500	$0
	(2500*(2+3+2)
Lease expenses	33750	0
Supervisor salary	12500	0
Total relevant cost	63750	62500
	Drop tHickness gauge and make
Purchase cost	0
Variable manfacturing cost	17500
Loss of contribution margin	42500
Total relevant cost	$60000
It is better to make as relevant cost is less than to buy from outside
So Drop thickness gauge
If any doubt please comment