Make or Buy, Traditional Analysis Morrill 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 $ 153,000 $ 81,600 $ 234,600 Less variable expenses 81,600 46,920 128,520 Contribution margin $ 71,400 $ 34,680 $ 106,080 Less direct fixed expenses 20,400 38,760 59,160 Segment margin $ 51,000 $ (4,080) $ 46,920 Less common fixed expenses 30,600 Operating income $ 16,320 Includes depreciation The density gauge uses a subassembly that is purchased from an external supplier for $25 per unit Each quarter, 2,040 subassemblies are purchased All units produced are sold, and there are no ending inventories of subassemblies Morrill 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 Morrill is considering two alternatives to supply the productive capacity for the subassembly Lease the needed space and equipment at a cost of $27,540 per quarter for the space and $10,200 per quarter for a supervisor There are no other fixed expenses 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 $38,760, $8,160 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 $ $ $ 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 2,856 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

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Make-or-Buy, Traditional Analysis Morrill Company produces two different types of gauges: a density gauge and a thickness gauge. The segmented income statement for a typical

Make-or-Buy, Traditional Analysis

Morrill 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	$	153,000	$	81,600	$	234,600
Less variable expenses		81,600		46,920		128,520
Contribution margin	$	71,400	$	34,680	$	106,080
Less direct fixed expenses*		20,400		38,760		59,160
Segment margin	$	51,000	$	(4,080)	$	46,920
Less common fixed expenses						30,600
Operating income					$	16,320

* Includes depreciation.

The density gauge uses a subassembly that is purchased from an external supplier for $25 per unit. Each quarter, 2,040 subassemblies are purchased. All units produced are sold, and there are no ending inventories of subassemblies. Morrill 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.

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

Lease the needed space and equipment at a cost of $27,540 per quarter for the space and $10,200 per quarter for a supervisor. There are no other fixed expenses.
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 $38,760, $8,160 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	$	$	$

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 2,856 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?