Henderson Company produces two products, A and B. The segmented income statement for a typical quarter is as follows:

Product A 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 of subassemblies. Henderson is considering making the subassembly rather than buying it. Unit variable manufacturing costs are as follows:

Two alternatives exist to supply the productive capacity:

a. 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.

b. Drop Product B. The equipment could be adapted with virtually no cost and the existing space utilized to produce the subassembly. The direct fixed expenses, including supervision, would be $38,000, $8,000 of which is depreciation on equipment. If Product B is dropped, there will be no effect on the sales of Product A.

REQUIRED:

1. Should Henderson 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 Product B will decrease sales of Product A by 6 percent. What effect does this have on the decision?

3. Assume that dropping Product B decreases sales of Product A by 6 percent 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?

'Includes depreciation. \begin{tabular}{lr} \hline Direct materials & $2 \\ Direct labor & 3 \\ Variable overhead & 2 \end{tabular}