"We ought to stop making our own drums and accept that outside supplier’s offer,” said Wim Niewindt, managing director of Antilles Refining, N.V., of Aruba. “At a price of $20 per drum, we would be paying $5.45 less than it costs us to manufacture the drums in our own plant. Because we use 80,000 drums a year, that equals an annual cost savings of $436,000.” Antilles Refining’s current cost to manufacture one drum is given below (based on 80,000 drums per year): Direct materials $ 12.00 Direct labor 6.50 Variable overhead 1.50 Fixed overhead ($2.90 general company overhead, $1.80 depreciation, and $0.75 supervision) 5.45 Total cost per drum $ 25.45 A decision about whether to make or buy the drums is especially important at this time because the equipment used to make the drums is completely worn out and must be replaced. The choices facing the company are: Alternative 1: Rent new equipment and continue to make the drums. The equipment would be rented for $180,000 per year. Alternative 2: Purchase the drums from an outside supplier at $20 per drum. The new equipment is more efficient than the company’s wornout equipment and would reduce direct labor and variable overhead costs by 30%. The old equipment has no resale value. Supervision cost ($60,000 per year) and direct materials cost per drum would not be affected by the new equipment. The new equipment’s capacity is 150,000 drums per year. The company’s total general company overhead would be unaffected by this decision. Required: Assuming 80,000 drums are needed each year, what is the financial advantage (disadvantage) of buying the drums from an outside supplier? Assuming 100,000 drums are needed each year, what is the financial advantage (disadvantage) of buying the drums from an outside supplier? Assuming 150,000 drums are needed each year, what is the financial advantage (disadvantage) of buying the drums from an outside supplier?
"We ought to stop making our own drums and accept that outside supplier’s offer,” said Wim Niewindt, managing director of Antilles Refining, N.V., of Aruba. “At a price of $20 per drum, we would be paying $5.45 less than it costs us to manufacture the drums in our own plant. Because we use 80,000 drums a year, that equals an annual cost savings of $436,000.” Antilles Refining’s current cost to manufacture one drum is given below (based on 80,000 drums per year):
| Direct materials | $ 12.00 |
|---|---|
| Direct labor | 6.50 |
| Variable |
1.50 |
| Fixed overhead ($2.90 general company overhead, $1.80 depreciation, and $0.75 supervision) | 5.45 |
| Total cost per drum | $ 25.45 |
A decision about whether to make or buy the drums is especially important at this time because the equipment used to make the drums is completely worn out and must be replaced. The choices facing the company are:
Alternative 1: Rent new equipment and continue to make the drums. The equipment would be rented for $180,000 per year.
Alternative 2: Purchase the drums from an outside supplier at $20 per drum.
The new equipment is more efficient than the company’s wornout equipment and would reduce direct labor and variable overhead costs by 30%. The old equipment has no resale value. Supervision cost ($60,000 per year) and direct materials cost per drum would not be affected by the new equipment. The new equipment’s capacity is 150,000 drums per year.
The company’s total general company overhead would be unaffected by this decision.
Required:
- Assuming 80,000 drums are needed each year, what is the financial advantage (disadvantage) of buying the drums from an outside supplier?
- Assuming 100,000 drums are needed each year, what is the financial advantage (disadvantage) of buying the drums from an outside supplier?
- Assuming 150,000 drums are needed each year, what is the financial advantage (disadvantage) of buying the drums from an outside supplier?
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