“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 $140,000 per
year.
Alternative 2: Purchase
carburetors from an outside supplier for $19.35 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
35,000 units per year:
| Direct materials | $ | 5.40 | |
| Direct labour | 10.00 | ||
| Variable overhead | 1.60 | ||
| Fixed overhead ($2.00 supervision, $1.80
depreciation, and $4.00 general company overhead) |
7.80 | ||
| Total cost per unit | $ | 24.80 | |
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
($70,000 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 35,000
carburetors are needed each year.
a. What will be the total relevant cost
of 35,000 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
Indifferent between the two alternatives
Purchase from the outside supplier
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 40,000 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 40,000 assemblies are needed each year?
Indifferent between the two alternatives
Purchase from the outside supplier
Manufacture internally
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
Purchase from the outside supplier
Manufacture internally
1
(a)What will be the total relevant cost of 35,000 subassemblies if they are manufactured internally as compared to being purchased?
Total relavant cost of producing components internally denotes total variable cost that will be incurred by the company during the production plus any additional cost that company incurred exclusively for the production alone
Relavant cost here would be : Direct labour, Direct material , Variable overhead, Rental charges of new equipment
Direct labour cost and Variable overhead go down by 25%
Revised Cost per units
Direct material cost = $5.4
Direct Labour cost=$10*.75
=7.5
Variable overhead:=1.6*.75
=1.2
Total variable costs= Direct mateial+Direct labour+Variable overhead
=5.4+7.5+1.2
=$14.1/unit
Total variable cost will incurred to produce 35000 units
=35000*14.1
=$493500
Total cost of rent / annum for the new machine=$1400000
Total relavant cost that will incurre to produce 35000 units
=493500+140000
=$633500
b)What would be the per unit cost of the each subassembly manufactured internally?
Total cost of manufacturing 35000 units internally= $633500
Unit production cost of each sub assembly= 633500/35000
=$18.1/unit
c. Which course of action would you recommend to the president?
Manufacture internally
Indifferent between the two alternatives
Purchase from the outside supplier
Total cost of purchasing the item from supplier= Cost/unit purchase*total units
=35000*19.35
=$677250
Total cost of items manufacturing internally=$633500
So producing items internally is the best option
Calculation of indifference point where total cost would be the same for both option
Total units can be X
19,35*x=140000+14.1x
X=26,667 units
* Fixed Cost are irrelavant for Decesion Making
2)
a-1. What will be the total relevant cost of 40,000 subassemblies if they are manufactured internally
Total variable costs= Direct mateial+Direct labour+Variable overhead
=5.4+7.5+1.2
=$14.1/unit
Total variable cost for producing 40000units=40000*14.1
=$564000
Total Cost of rent/Annum=$140000
Total Relavant cost of sub assemblies= 564000+140000
=$704000
a-2. What would be the per unit cost of subassembly?
Total cost of manufacturing 400000 units internally= $704000
Unit production cost of each sub assembly= 704000/40000
=$17.6/unit
a-3. Which course of action would you recommend if 40,000 assemblies are needed each year?
Indifferent between the two alternatives
Purchase from the outside supplier
Manufacture internally
Total cost of purchasing the item from supplier= Cost/unit purchase*total units
=40000*19.35
=$774,000
Total cost of items manufacturing internally=$704,000
So producing items internally is the best option
Calculation of indifference point where total cost would be the same for both option
Total units can be X
19,35*x=140000+14.1x
X=26,667 units
* Fixed Cost are irrelavant for Decesion Making
b-1. What will be the total relevant cost of 50,000 subassemblies if they are manufactured internally?
Total variable costs= Direct mateial+Direct labour+Variable overhead
=5.4+7.5+1.2
=$14.1/unit
Total variable cost for producing 50000units=50000*14.1
=$70,5000
Total Cost of rent/Annum=$140000
Total Relavant cost of sub assemblies= 705000+140000
=$845,000
b-2. What would be the per unit cost of subassembly?
What would be the per unit cost of subassembly?
Total cost of manufacturing 500000 units internally= $845,000
Unit production cost of each sub assembly= 845,000/50000
=$16.9/unit
b-3. Which course of action would you recommend if 50,000 assemblies are needed each year?
Indifferent between the two alternatives
Purchase from the outside supplier
Manufacture internally
Total cost of purchasing the item from supplier= Cost/unit purchase*total units
=50000*19.35
=$967,500
Total cost of items manufacturing internally=$845,000
So producing items internally is the best option
Calculation of indifference point where total cost would be the same for both option
Total units can be X
19,35*x=140000+14.1x
X=26,667 units
* Fixed Cost are irrelavant for Decesion Making
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