Homework: Chapter 17 Make-or- Buy, Traditional Analysis Morrill Company produces two different types of gaudes: a density gauge and a thickness gauge. The segmented income statement for a typical quarter follows. Density Thickness Gauge Gauge Total Sales $ 213,000 $ 113,600 $ 326,600 Less variable expenses 113,600 65,320 178,920 Contribution margin $ 99,400 $ 48,280 $147,680 Less direct fixed expenses 28,400 53,960 82,360 Segment margin $ 71,000 $ (5,680) $ 65,320 Less common fixed expenses 42,600 > Operating income $ 22,720 Indudes depreciation. The density gauge uses a subassembly that is purchased from an external supplier for $25 per unit. Each quarter, 2,840 subassemblies are purchased. All units produced are sold, and there are no ending Inventories of subassemblies. Morrill is considering making the subassembly rather than a . buying it. Unit-level variable manufacturing costs are as follows: Direct materials $2 Direct labor 3 Variable overhead 2 No significant non-unit-level costs are incurred. Morrill is considering two alternatives to supply the productive capacity for the subassembly. 1. Lease the needed space and equipment at a cost of $38,340 per quarter for the space and $14,200 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, including supervision, would be $53,960, $11,360 of which is depredation on equipment. If the thickness gauge is dropped, sales of the density gauge will not be affected, Required: 1. Should Morrill Company make or buy the subassembly? ? Make the subassembly If it makes the subassembly, which alternative should be chosen? Drop the thickness gauge Enter the relevant costs of each alternative Direct materials $2 Direct labor 3 Variable overhead 2 No significant non-unit-level costs are incurred. Morrill is considering two alternatives to supply the productive capacity for the subassembly 1. Lease the needed space and equipment at a cost of $38,340 per quarter for the space and $14,200 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, including supervision, would be $53,960, $11,360 of which is depreciation on equipment. If the thickness gauge is dropped, sales of the density gauge will not be affected. Required: 1. Should Morrill Company make or buy the subassembly? Make the subassembly If it makes the subassembly, which alternative should be chosen? Drop the thickness gauge Enter the relevant costs of each alternative. Lease and Make Buy Drop Thickness Gauge and Make Total relevant costs $ 71,000 2. Suppose that dropping the thickness gauge will decrease sales of the density gauge by 10 percent. What decision should now be made? Keep the thickness gauge and buy the subassembly 3. Assume that dropping the thickness gauge decreases sales of the density gauge by 10 percent and that 3,976 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? Lease the space and make the subassembly Feedback Check My Work 1. Relevant costs and revenues) are future costs and revenues) that differ across alternatives. For each cost and revenue given, ask yourself if the company would incur different amounts of the costs, in total, for each alternative. Set up the analysis with the relevant costs and revenues organized under a column heading for each alternative. 2 & 3. Review what you have learned in the chapter