Make-or-Buy, Traditional Analysis

Garcia Company produces two different types of gauges: a density gauge and a thickness gauge. The segmented income statement for a typical quarter follows.

	Density Gauge	Thickness Gauge	Total
Sales	$	169,500	$	90,400	$	259,900
Less variable expenses		90,400		51,980		142,380
Contribution margin	$	79,100	$	38,420	$	117,520
Less direct fixed expenses*		22,600		42,940		65,540
Segment margin	$	56,500	$	(4,520)	$	51,980
Less common fixed expenses						33,900
Operating income					$	18,080
* Includes depreciation.

The density gauge uses a subassembly that is purchased from an external supplier for $25 per unit. Each quarter, 2,260 subassemblies are purchased. All units produced are sold, and there are no ending inventories of subassemblies. Garcia is considering making the subassembly rather than 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.

Garcia is considering two alternatives to supply the productive capacity for the subassembly.

1. Lease the needed space and equipment at a cost of $30,510 per quarter for the space and $11,300 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 $42,940, $9,040 of which is depreciation on equipment. If the thickness gauge is dropped, sales of the density gauge will not be affected.

Required:

1. Should Garcia Company make or buy the subassembly?

Buy the subassemblyMake the subassemblyMake the subassembly

If it makes the subassembly, which alternative should be chosen?

Drop the density gaugeDrop the thickness gaugeDrop the thickness gauge

Enter the relevant costs of each alternative.

	Lease and Make	Buy	Drop Thickness Gauge and Make
Total relevant costs	$fill in the blank 3	$fill in the blank 4	$fill in the blank 5

2. Suppose that dropping the thickness gauge will decrease sales of the density gauge by 10 percent. What decision should now be made?

Drop the thickness gauge and produce the subassemblyKeep the thickness gauge and buy the subassemblyKeep 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 3,164 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?

Drop the thickness gauge and produce the subassemblyKeep the thickness gauge and buy the subassemblyLease the space and make the subassemblyLease the space and make the subassembly