Reference no: EM132581068

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.

Required:

Question (a) Which, if any, of the above costs are not relevant to this decision? Why?

Question (b) Assume that 40,000 sub-assemblies are needed each year. Make an analysis of the two alternatives and make a recommendation to the management of the company of the appropriate course of action.