The Nippon Company purchases 80,000 pumps annually from Xing Brothers, Inc. The price has increased each year and reached $68 per unit last year. Because the purchase price has increased significantly, Nippon management has asked its analyst to estimate the cost to manufacture the pump in its own facilities. Nippon’s products consist of stamping and castings. The company has little experience with products requiring assembly. The engineering, manufacturing, and accounting departments have prepared a report for management that includes the following estimate for an assembly run of 10,000 units. The firm would hire additional production employees to manufacture the subassembly. It would not need extra equipment, space, or supervision. The report estimates total costs for 10,000 units at $957,000, or $95.70 per unit. The current purchase price is $68 per unit, so the report recommends continued purchase of the product.

Components (outside purchases)......................................$120,000

Assembly labora................................................................ 300,000

Factory overheadb............................................................. 450,000

General and administrative overheadc.............................. 87,000

Total Costs........................................................................$957,000

Fixed overhead..................................................... 50 percent of direct labor dollars

Variable overhead................................................. 100 percent of direct labor dollars

Factory overhead rate........................................... 150 percent of direct labor dollars

aAssembly labor consists of hourly production workers.

bFactory overhead is applied to products on a direct labor dollar basis. Variable overhead costs vary closely with direct labor dollars.

cGeneral and administrative overhead is applied at 10 percent of the total cost of material (or components), assembly labor, and factory overhead.

a. Was the analysis prepared by the engineering, manufacturing, and accounting departments of Nippon Company and the recommendation to continue purchasing the pumps that followed from the analysis correct? Explain your answer and include any supportive calculations you consider necessary.

b. Assume Nippon Company could experience labor cost improvements on the pump assembly consistent with an 80 percent learning curve. An assembly run of 10,000 units represents the initial lot or batch for measurement purposes. Should Nippon produce the 80,000 pumps in this situation? Explain your answer.