Problem #4. (20 Points)

Heads Annual Report says that virtually all of its products are produced by independent

contractors. Suppose that in one of those contracted production facilities where Head golf clubs are produced, Head estimates the need for 20,000 specialized head casings per year over the next 5 years for a custom driver club it manufactures. It can either make the casings internally or purchase them from an outside supplier for $29.75 per unit. If it makes the casings, it will have to purchase equipment costing $300,000 that has a 5-year life and no salvage value (assume straight line depreciation).

The machine can produce up to 40,000 casings per year. The production manager thinks the company should purchase the casings based on the following information he has prepared concerning the internal manufacture of 20,000 casings per year:

Per unit

Direct materials $12.00

Direct labor 8.00

Variable overhead 4.50

Depreciation 3.00

Supervision 1.50

Rent 3.00

Total cost $32.00

A supervisor would have to be hired and paid a salary of $30,000 to oversee production of the casings.

The rent charge is based on the space utilized in the plant, but there is excess plant space available to manufacture the casings. Total rent on the plant is $250,000 per period.

1. If the casings are made internally, will the company be better off or worse off, and by how much?

2. If it is estimated that only 15,000 casings per year were required, should Head make or buy them? Show the cost calculations of each. What is the difference?

Show ALL of your calculations.