How should I go about doing this?

Make or Buy? (ICAO) ent. (Ignore income taxes and the C9-5 Panadagan Vacuums Limited (PVL) is a worldwide leader in the manufacturing 2 of industrial vacuums. The company is located in Thorold, Ontario. PVL sells vacuums to distributors in North America, Europe, and Asia. Over the last 10 years, PYL, has seen its sales and market share deteriorate due to foreign compe- tition. While PVL is considered a leader in product development and quality, the company has been unable to secure large contracts due to its higher-than- Canada. average selling prices. Management attributes this to the high cost of labour in PVL has two divisions-the vacuum-assembly division and the components- production division. Currently, PVL manufactures seven standard industrial- vacuum models in its vacuum-assembly division. This division also manufactures special order models for its customers when its standard models are unsuitable. The vacuum-assembly division also has a service department that repairs vacuums under warranty or, when the warranty has expired, for a service fee. PVL's distributors also provide warranty service on PVL's behalf. PVL's components-production division currently produces about 60 percent of the components used in the manufacturing of its vacuums. The other 40 percent is purchased from external suppliers by the vacuum-assembly division. Components are sold from the components-production division to the vacuum-assembly division using a negotiated transfer price, which approximates market value. Recently, PVL was approached by a Korean manufacturing company, Engine Tech Limited (ETL). ETL specializes in manufacturing small engines. ETL has proposed an arrangement whereby it would produce engine model P12, which PVL currently uses in two of its standard vacuum models. PVL currently produces these engines in its components division. ETL has agreed to provide P12 engines for a five-year period at a cost of 130,000 Korean won per unit. At current exchange rates, this would amount to $2,200 Canadian per unit. Duty and freight would cost approximately $300 Canadian per unit for a total of $2,500 Canadian per unit. PVL would agree to purchase a minimum of 5,000 units per year during the five-year term of the contract. If PVL failed to purchase the minimum amount, it would be required to pay a penalty of 30,000 Korean won (currently $500 Canadian) per unit of shortfall from the minimum. This penalty payment would be due at the end of the year in which the shortfall occurs. PVL is considering modifying two of its existing models so that they use the P12 engine. The Model 3 unit could be modified to use the P12 engine instead of its existing engine, the P10, which is a less powerful engine than the P12. If this occurs, the cost of the engine to the vacuum-assembly division would increase by $1,000 per unit. All other costs would remain the same. Annual sales of the Model 3 would be expected to rise by 20 percent if this modification was made. PVL is also considering modifying the Model 4A to use the P12 engine instead of its existing engine, the P14, which is a more powerful engine than the P12. If this occurs, the cost of the engine to the vacuum-assembly division would decrease by $1,000 per unit. All other costs would remain the same. Annual sales of the Model 4A would be expected to decrease by 20 percent if this modification was made. You are the assistant controller of PVL. The controller of PVL has asked you to prepare a report to her on whether the offer from ETL should be accepted. She would also like you to discuss whether the P12 engine should be used in Models 3 and 4A. To assist you in your analysis, she has asked the accounting and marketing departments of the vacuum-assembly division to prepare information on expected sales and costs for the seven standard models that PVL produces (Exhibit 9A-1). This information represents management's best estimate of aver- Relevant Information and age selling prices and costs for the five-year term of the contract proposed by Decision Making: Production DecisionsL. Costs and selling prices are not expected to change therandally over the year term of the contract. The controller has also had ife accounting dege bitof the component production division provide you e not as expected cost pducing the P12 engine (Exhibit 9A-2). These costs are get winested to chats of postantially over the five-year term of the proposed contract with ETL eithang the controller has instructed you to provide a quantitative analysis of the der sions in your report. She would also like your report to address the qualitative aspects of these decisions. REQUIRED Prepare the report requested by the controller. EXHIBIT 9A-1 Panadagan Vacuums Limited Information on Standard Models Estimated (1) Engine Model Engine Selling Annual Sales Used Source Model Price Volume (units) 3 $20,000 4,000 P10 External vendor $25,000 2,000 P12 Components division 3A 4 $40,000 2,000 P12 Components division 4A $50,000 1,500 P14 External vendor 5 $70,000 500 P16 External vendor 6 $80,000 500 $4 Components division $95,000 200 S8 Components division Note 1: Estimated sales volumes were prepared by the marketing department of PVL. Historically, the marketing department's estimates have been reasonably accurate. Current Production Costs (in dollars) Model 3 3A 4 4A 5 6 7 Labour $5,000 $7,000 $11,000 $15,000 $20,000 $25,000 $30,000 Divisional Overhead (1) 1,000 1,400 2,200 3,000 4,000 5,000 Components 6,000 Engine 3,000 Housing 4,000 4,000 2,000 15,000 Other 2,500 5,000 3,000 7,000 6,000 6,100 3,500 10,000 9,000 4,000 18,400 6,000 7,000 Total Cost 20,200 $17,000 20,200 $21,000 28,000 $29,200 $44,900 $55,200 $66,200 $86,000 Note 1: Divisional overhead has been applied at a rate of 20 percent of direct labour. Divisional overhead includes purchasing costs, management salaries, rent, utilities, warranty service costs, and administrative costs. APTER 9he EXHIBIT 9A-2 part- sts of Exdagan Vacuums Limited Information on Current Cost of Producing P12 Engine inge Process Description division's purchasing department purchases all of the subcomponents needed to produce the engine. These subcomponents The On inspected. The engine is then assembled and inspected before being transferred to the vacuum-assembly division. Production Costs per Unit: Materials and subcomponents Direct Labour (including employee benefits): $1,200 Subcomponent inspection Assembly 100 (1) Testing 500 (2) 150 (3) Identifiable overhead: Depreciation of equipment Management salaries 300 (4) Rent 240 ( 5 ) Repairs and maintenance of equipment 200 (6) Other 200 (7) 300 (8) Allocated divisional overhead 300 (9) $3,490 Note 1. Costs consist of a supervisor and a team of inspection workers. One inspection worker can, in one year, inspect the components needed to workers. assemble 500 engines. Each inspector's yearly salary and benefits costs $40,000. One supervisor is needed who can supervise up to 20 inspection Based on annual production of 4,000 units, expected costs are: Inspection workers 4,000 units/500 units per worker x $40,000 Supervisor's salary and benefits $320,000 80,000 $400,000 Annual production 4,000 Cost per unit 100 Note 2. Assembly is conducted by production teams. Each team can assemble up to 500 units per year. Each team consists of 10 workers and a supervisor. Total salaries and benefits per team averages $250,000 per year. Cost per team $250,000 Production per team 500 Cost per unit 500 Note 3. Costs consist of quality control inspectors, who each receive an annual salary and benefits of $75,000 per year. Each can inspect a maxi- mum of 500 units per year. Cost per inspector $ 75,000 Units inspected 500 Cost per unit $ 150 Note 4. Depreciation is calculated based on the percentage of use of the component production division's machines. Currently, these machines being used at 70% of their full capacity. All of these machines are required for the production of components other than the P12. Cost is deter- mined as follows: Relevant Information and Decision Making: Production Decisions$ 9,000 Cost per hour of machine usage 30 Units produced per hour $300.00 Charge per hour Management salaries are the salaries for 14 managers who work exclusively on the Piz. These costs are frontierperiod to increase if ume of P12 engines produced changes. $960,000 Annual costs 4,000 Units produced 240 Cost per unit Note 6. Rent relates to space used exclusively in the plant for the production of the P12 engine. The space penny being used would allow component production division to produce up to 90,000 units per year without any increase in costs. If the fit theme was no longer manyy the tured, PVL could sublease the space currently used for manufacturing this component. However, it would only be able to recover 50% of jac it is currently incurring. Annual cost $800,000 Units produced 4,000 Cost per unit 200 Note 7. Repairs and maintenance costs (like depreciation) are also allocated based on machine usage. The actual amount of repairs and main nance costs incurred during a year has been found to be directly related to the number of machine hours used. Rate per hour of usage $ 6,000 Units produced per hour 30 Costs per unit $ 200 Note 8. Other overhead consists of utilities, training, and other administrative costs. Approximately 50% of these costs are dependent upon the volume of units produced. The other 50% of these costs is not dependent on the volume of units produced. Expected annual cost based on 4,000 units produced Annual volume $1,200,000 Cost per unit 4,000 300 Note 9. Divisional overhead costs consist of costs that cannot be specifically attributed to a particular component. Divisional overhead costs are allocated based on the direct labour costs attributable to each component. Based on past results, a rate of 40% of direct labour is used to allocate divisional overhead. These costs are expected to remain the same regardless of the volume of P12 engines produced. EXCEL APPLICATION EXERCISE Identifying Relevant Revenue, Costs, and Income Effects Goal: Create an Excel spreadsheet to assist with sell-or-process-further decisions by identifying the relevant revenue, costs, and income effects. Use the results to answer questions about your findings. Scenario: Mussina Chemical Company has asked you to prepare an analysis to help decisions about whether to sell joint products at the split-off point or process them ther. Prepare the report of your analysis using a format similar to the one on page ? Joint Products: Sell or Process Furth