Reference no: EM131133889

PROBLEM 12-27 Make or Buy Analysis [LO2]

"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 out- side supplier. The alternatives follow:

Alternative 1: Rent new equipment for producing the carburetors for $120,000 per year.

Alternative 2: Purchase carburetors from an outside supplier for $16 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 40,000 units per year:

Direct materials. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	$ 5.50
Direct labour. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	8.00
Variable overhead . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	1.20
Fixed overhead ($1.50 supervision, $1.80 depreciation,
and $4 general company overhead) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	7.30
Total cost per unit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .	$22.00

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 ($60,000 per year) and direct materials cost per unit would not be affected by the new equipment. The new equipment's capacity would be 60,000 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 40,000 carburetors are needed each year. Which course of action would you recommend to Seebach?

2. Would your recommendation in (1) above be the same if the company's needs were (a) 50,000 carburetors per year, or (b) 60,000 carburetors per year? Show computations in good form.

3. What other factors would you recommend that Seebach consider before making a decision?