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 $ 168,000 89,600 $89,600 51,520 $257,500 141,120 Less variable expenses Contribution margin Less direct fixed expenses* $ 78,400 22,400 $ 56,000 $ 38,080 42,560 $(1,480) $ 116,480 6 4,960 $ 51,520 Segment margin Less common fixed expenses 33,600 Operating income $ 17,920 * Includes depreciation. The density gauge uses a subassembly that is purchased from an extemal supplier for $25 per unit. Each quarter, 2.240 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 Variable overhead 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 $30,240 per quarter for the space and $11,200 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 $42,560, 54,960 of which is depreciation on equipment. If the thickness gauge is dropped, sales of the density gauge will not be affected. Required: 1. Should Mornil 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 $ 57,120 $ 56,000 $ 49,280 X 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