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PROBLEM 12-27 Make or Buy Analysis 02|| "That old equipment for producing oil drums is worn out," said Bill Sechach, president of Hondrich Company. "We need to make a decision quickly." The company is trying to decide whether it should rent new equipment and continue to make its oil drums internally or whether it should discontinue production and purchase them from an outside supplier. The alternatives follow Alternative 1: Rent new equipment for producing the oil drums for S120,000 per year. Alternative 2. Purchase oil drums from an outside supplier for S16 each. Hondrich Company's costs per unit of producing the oil drums internally (with the old equipment) are given below. These costs are based on a current activity level of 40,000 units per year S 5.50 8.00 1.20 Direct materials Direct labour Variable overhead Fixed overhead ($1.50 supervision, $1.80 depreciation, and $4 general company overhead) Total cost per unit 7.30 $22.00 The new equipment would be more efficient and, according to the manufacturer, would reduce direct labour costs and variable overhead costs by 25%. Supervision cost ($60,000 per year) and direct materials cost per unit would not be affected by the new equipment. The new equipment's capacity would be 60,000 oil drums per year. The total general company overhead would be unaffected by this decision Required: 1. Seebach is unsure what the company should do and would like an analysis showing the unit costs and total costs for each of the two alternatives given above. Assume that 40.000 oil drums are needed each year. Which course of action would you recommend to Seebach? 2. Would your recommendation in (1) above be the same if the company's needs were () 50.000 oil drums per year, or (b) 60.000 oil drums per year? Show computations in good form. 3. What other factors would you recommend that Seebach consider before making a decision? 1 Problem 12-27 (Parts 1 and 2) 2 Part 1 of Hondrich makes the oil drums, they will do it with NEW rented equipment. That new equipment may 3 change the cost of making the drums from their current costs. "Supervision cost ($60,000 per year) and direct materials cost per unit would not be affected by the new equipment." That means the costs would be the same with the new equipment as they are with the old 4 equipment 5 6 Volume 7 Per Unit Differential Costs Total Units Make with new Make with new equipment Buy equipment Buy 9 10 8 OO 11 12 13 14 15 Total costs 16 17 18 18 19 Part 2 20 Volume 21 Per Unit Differential Costs Make with new equipment Total Units Make with new equipment Buy Buy 22 23 24 25 26 27 28 29 Total costs 3 3 30 31 32 N- 33 Part 2b 34 Volume 35 Per Unit Differential Costs Make with new equipment Total Units Make with new equipment Buy Buy 36 37 38 39 40 41 42 43 Total costs 44 45 46 47
