Reference no: EM132580953
The Hyatt Company is trying to decide whether it should purchase new equipment and continue to make its sub-assemblies internally or if production should be discontinued and the sub-assembly purchased from an outside supplier.
New equipment for producing the sub-assemblies can be purchased at a cost of $400,000. The equipment would have a five-year useful life (the company uses straight-line depreciation) and a $50,000 salvage value.
Alternatively, the sub-assemblies could be purchased from an outside supplier. The supplier has offered to provide the sub-assemblies for $9 each under a five-year contract.
Hyatt Company's present costs per unit of producing the sub-assemblies internally (with the old equipment) are given below. The costs are based on a current activity level of 40,000 sub-assemblies per year:
Direct materials $ 3.00
Direct labour $ 4.20
Variable overhead $ 0.60
Fixed overhead $ 3.70
Total cost per unit $ 11.50
(Fixed overhead includes $0.80 supervision, $0.90 depreciation, and $2 general company overhead)
The new equipment would be more efficient and would reduce direct labour costs and variable overhead costs by 25%. The company has no other use for the space now being used to produce the sub-assemblies. The company's total general company overhead would not be affected by this decision. Assume direct labour is a variable cost.
Question 1: Which, if any, of the above costs are not relevant to this decision? Why?
Question 2: Assume that 40,000 sub-assemblies are needed each year. give an analysis of the two alternatives and make a recommendation to the management of the company of the appropriate course of action.