Question

Simple Grill operates in Hilliard, Ohio and produces gas grills. This year’s expected production is 25,000 grills. Currently, Simple makes all the side burners for the grills, where each grill includes two side burners. Simple’s management accountant reports the following costs for making 50,000 burners:

	Cost per unit	Costs for 50,000 units
Direct materials	$       10.00	$     500,000
Direct manufacturing labor	5.00	250,000
Variable manufacturing overhead	2.50	125,000
Inspection, setup, materials handling		12,000
Machine rent		29,000
Allocated fixed costs (taxes, insurance, etc.)		125,000
Total costs		$   1,041,000

The following information is available:

• Inspection, setup, and materials-handling costs vary in direct proportion to the number of batches in which the burners are produced. Simple produces burners in batch sizes of 1,000 burners per batch so Simple will produce the 50,000 burners in 50 batches.
• Simple leases the machine it uses to make the burners. If Simple buys all of its burners from the outside vendor, it will no longer pay the rent on this machine.
• Simple received an offer from an outside vendor to supply any number of burners required at a price of $18.50 per burner.

1. Assume that if Simple purchases the burners from the outside vendor, Simple will continue to pay all of the $125,000 allocated fixed costs of the facility where the burners are currently made, though the facility will remain idle. Should Simple accept the outside vendor’s offer at the anticipated volume of 50,000 burners? Show your analysis.
2. For this question, assume that if the burners are purchased outside, Simple will use the facility where the burners are currently made to upgrade the grills by adding a rotisserie attachment. (Note: each grill will still contain two side burners and will now have one rotisserie attachment). As a consequence, the selling price of the enhanced grills will be raised by $60. The variable cost per unit of the upgrade would be $50, and additional tooling costs of $200,000 per year would be incurred. Should Simple make the burners and continue to offer the original model grill or buy the burners and offer the enhanced model grill? Assume that under either option, 25,000 grills will be produced and sold.
3. Refer back to the information in the original problem. The sales manager at Simple is concerned that the estimate of 25,000 grills may be high and believes that only 20,000 grills will be sold. Production will be cut back, freeing up space in the production facility. This freed-up space can be used to produce the rotisserie attachments whether Simple buys the burners or makes them in-house. At this lower output level of 20,000 grills, Simple will produce the burners in 40 batches of 1,000 units each. Should Simple make the burners or buy the burners under the assumption that they will sell 20,000 units of the enhanced model grill under either alternative? Show your analysis.

Answer 1

Answers:

Requirement 1: Assume that if Simple purchases the burners from the outside vendor, Simple will continue to pay all of the $125,000 allocated fixed costs of the facility where the burners are currently made, though the facility will remain idle. Should Simple accept the outside vendor’s offer at the anticipated volume of 50,000 burners? Show your analysis.

Calculation:

We have option to buy 50000 burners from outside vendor.

Computation of cost when buy from outside vendor

Per unit price is = 18.5

Units required = 50,000

Total Cost = 18.5 * 50,000 = 925,000

Computation of cost when in-house production

	Costs for 50000 Units
Direct materials	$500,000
Direct manufacturing labor	$250,000
Variable manufacturing overhead	$125,000
Inspection, setup, materials handling	$12,000
Machine rent	$29,000
Total relevant costs	$916,000

Note : We will not consider the "Allocated fixed costs of plant administration, taxes, and insurance" of $125,000 because it is irrelevant cost, no matter production is done or not this cost will be incur, so we will not consider it while decision making.

Decision : Make Burners. Simple doesnt need to accept the outside vendor’s offer at the anticipated volume of 50,000 burners. From above two calculations we can infer that the cost of 50000 burners when made in in-house it cost $916,000 and when ordered from outside vendor it cost $925,000. So it is advised to produce the burners instead of ordering.

Requirement 2: For this question, assume that if the burners are purchased outside, Simple will use the facility where the burners are currently made to upgrade the grills by adding a rotisserie attachment. (Note: each grill will still contain two side burners and will now have one rotisserie attachment). As a consequence, the selling price of the enhanced grills will be raised by $60. The variable cost per unit of the upgrade would be $50, and additional tooling costs of $200,000 per year would be incurred. Should Simple make the burners and continue to offer the original model grill or buy the burners and offer the enhanced model grill? Assume that under either option, 25,000 grills will be produced and sold.

Calculation:

Here, if the burners are not produced then we can increase our selling price by $60 per unit and additional variable cost of $50 and fixed cost of $200,000 will be incurred.

Net benefit = ($60 - $50) * 25000 grills - $200000 = $50000

So, if ordered from outside we will have an additional profit of $50000.

Computation of cost when buy from outside

Per unit price is = 18.5

Units required = 50,000

Total Cost = 18.5 * 50,000 = 925,000

Less: Additional benefit of = 50000

Net cost will be = 875,000

Computation of cost when in-house production

	Costs for 50,000 Units
Direct materials	$500,000
Direct manufacturing labor	$250,000
Variable manufacturing overhead	$125,000
Inspection, setup, materials handling	$12,000
Machine rent	$29,000
Total relevant costs	$916,000

Note : Here we will not consider the "Allocated fixed costs of plant administration, taxes, and insurance" of $125,000 because it is irrelevant cost, no matter production is done or not this cost will be incur, so we will not consider it while decision making.

Decision : Buy Burners. From above two calculations we can see cost of 50,000 burners when made in in-house it cost $916,000 but when purchase from outside it cost $875,000. So it is advised to purchase the burners instead of in-house production.

Requirement 3: Refer back to the information in the original problem. The sales manager at Simple is concerned that the estimate of 25,000 grills may be high and believes that only 20,000 grills will be sold. Production will be cut back, freeing up space in the production facility. This freed-up space can be used to produce the rotisserie attachments whether Simple buys the burners or makes them in-house. At this lower output level of 20,000 grills, Simple will produce the burners in 40 batches of 1,000 units each. Should Simple make the burners or buy the burners under the assumption that they will sell 20,000 units of the enhanced model grill under either alternative? Show your analysis.

Calculation:

Here it is assumed that only 20,000 grills can be sold and hence only 40,000 burners are required which are to be produced in 40 batches so the inspection cost will be reduced to $9,600 from $12,000 (because per batch inspection cost is $240 ($12000/50 batch))

Per unit price	18.5
Units required	40,000
Total Cost (unit price * units required)	740,000

Computation of cost when in-house production

	Costs for 40000 Units
Direct materials	$400,000
Direct manufacturing labor	$200,000
Variable manufacturing overhead	$100,000
Inspection, setup, materials handling	$9,600
Machine rent	$29,000
Total relevant costs	$738,600

Here, we will not consider the "Allocated fixed costs of plant administration, taxes, and insurance". No matter production is done or not, this cost will be incur, so we will not consider it while decision making.

Decision : Make Burners. From above two calculations we can see cost of 40,000 burners when made in in-house it cost $738,600 but when ordered outside it cost $740,000. So it is advised to make the burners instead of ordering.