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

The density gauge uses a subassembly that is purchased from an external supplier for $25 per unit. Each quarter, 2,000 subassemblies are purchased. All units produced are sold, and there are no ending inventories ofsubassemblies. Morrill is considering making the subassembly rather than buying it. Unit-level variable manufacturing costs are as follows:

There are no significant nonunit-level costs.
Morrill is considering two alternatives to supply the productive capacity for the subassembly.
1. Lease the needed space and equipment at a cost of $27,000 per quarter for the space and $10,000 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, in¬
cluding supervision, would be $38,000, $8,000 of which is depreciation on equipment.
If the thickness gauge is dropped, there will be no effect on the sales of the density gauge.
Required:
1. Should Morrill Company make or buy the subassembly? If it makes the subassembly, which alternative should be chosen? Explain and provide supporting computations.
2. Suppose that dropping the thickness gauge will decrease sales of the density gauge by 107o. What effect does this have on the decision?
3. Assume that dropping the thickness gauge decreases sales of the density gauge by 10%
and that 2,800 subassemblies are required per quarter. As before, assume that there are no ending inventories of subassemblies and that all units produced are sold. Assume also that the per-unit sales price and variable costs are the same as in Requirement 1.
Include the leasing alternative in your consideration. Now what is the correct decision?

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Sales Less: Variable expenses Contribution margin Less: Direct fixed expenses* Segment margin Less: Common fixed expenses Operating income $150,000 80,000 $ 70,000 Density Gauge Thickness Gauge Total $80,000 46,000 $34,000 38,000 $230,000 126,000 $104,000 58,000 $ 46,000 30,000 $ 16,000 20,000 $ 50,000 $ (4,000) *Includes depreciation.