Wool Incorporated

Wool Incorporated manufactures clothing from wool. Planning for next year, Wool Inc. has

consulted you to provide your recommendation on various business decisions. Use your

knowledge of relevant costs for decision making to provide a recommendation for each of the 4

business decisions.

Decision 2

Wool Inc. manufactures poms that it uses in several of its products. Management is considering

whether to continue manufacturing the poms or to buy them from an outside source. The

following information is available:

The company needs 20,000 poms per year. The poms can be purchased from an outside

supplier at a cost of $7.50 per unit.

The unit cost of manufacturing the poms is $8.50, computed as follows.

Direct materials $ 40,000

Direct labour 50,000

Factory overhead:

Variable 35,000

Fixed, traceable 25,000

Fixed, common but allocated 20,000

Total manufacturing costs $170,000

Cost per unit ($170,000 20,000 units) $8.50

Discontinuing the manufacture of poms will eliminate all the raw materials, direct labour, and

variable overhead costs but will eliminate only 80 percent of the fixed traceable factory

overhead costs.

The special equipment used to produce the poms has no resale value. No other reductions in

fixed factory overhead will result from discontinuing the production of poms.

Required:

a. Assuming Wool Inc. has no alternative use for the facilities now being used to

manufacture the poms, would you recommend that the company manufacture the

poms or buy them from the outside source? Show all calculations.

b. Assume that if the poms are purchased from the outside source, the factory space

previously used to produce poms can be used to manufacture an additional 8,000

tassels per year. Tassels have an estimated segment margin of $3,000. Would this

new assumption change your recommendation as to whether to make or buy the

poms? Show all calculations.