2. An analvsis by Deep Earth Oil Refinery recommends buying oil containers from an outside supplier for $18

per container. The analysis shows the company would be paying $5 less than it costs to manufacture the containers in its own plant. According to the analysis, since they use 60,000 containers a year, that would be an annual cost savings of $300,000." Deep Earth's present cost to manufacture one container is given below.

Based on normal production of 60,000 units per year.

Direct materials

$10.35

Direct labor

6.00

Variable overhead

1.50

Fixed overhead ($2.80 general company overhead, $1.60 depreciation, and $.75 supervision)

5.15

Total cost per container

$23.00

The choices facing the company are:

Alternative I: Purchase new equipment and continue to make the containers. The equipment would cost $810,000; it would have a six-year useful life and have no salvage value. The company uses straight-line depreciation. The new equipment would be more efficient than the old equipment and would reduce direct labor and variable overhead costs by 30 percent. Supervision costs ($45,000 per year) and direct materials cost per container would not be affected by the new equipment. The new equipment's capacity would be 90,000 containers per year. The company has no other use for the space now being used to produce the containers.

Alternative 2: Purchase the containers from an outside supplier at $18 per drum under a six-year contract.

Required:

a.

Prepare an incremental (make or buy) analysis showing both the total costs and the cost per container under each of the two alternatives. Assume that 60,000 containers are needed each year. Make a recommendation to the president.

b.

Prepare a new analysis assuming that 75,000 containers per year are needed. Does your recommendation change? If so, explain why.

C.

Prepare a new analysis assuming that 90,000 containers per year are needed. Does your recommendation change? If so, explain why.