Question

Make-or-Buy, Traditional Analysis

Morrill Company produces two different types of gauges: a density gauge and a thickness gauge. The segmented income statement for a typical quarter follows.

	Density Gauge		Thickness Gauge		Total
Sales	$	136,500	$	72,800	$	209,300
Less variable expenses		72,800		41,860		114,660
Contribution margin	$	63,700	$	30,940	$	94,640
Less direct fixed expenses*		18,200		34,580		52,780
Segment margin	$	45,500	$	(3,640)	$	41,860
Less common fixed expenses						27,300
Operating income					$	14,560
* Includes depreciation.

The density gauge uses a subassembly that is purchased from an external supplier for $25 per unit. Each quarter, 1,820 subassemblies are purchased. All units produced are sold, and there are no ending inventories of subassemblies. Morrill is considering making the subassembly rather than buying it. Unit-level variable manufacturing costs are as follows:

Direct materials	$2
Direct labor	3
Variable overhead	2

No significant non-unit-level costs are incurred.

Morrill is considering two alternatives to supply the productive capacity for the subassembly.

1. Lease the needed space and equipment at a cost of $24,570 per quarter for the space and $9,100 per quarter for a supervisor. There are no other fixed expenses.
2. Drop the thickness gauge. The equipment could be adapted with virtually no cost and the existing space utilized to produce the subassembly. The direct fixed expenses, including supervision, would be $34,580, $7,280 of which is depreciation on equipment. If the thickness gauge is dropped, sales of the density gauge will not be affected.

Required:

1. Should Morrill Company make or buy the subassembly?
Make the subassembly

If it makes the subassembly, which alternative should be chosen?
Drop the thickness gauge

Enter the relevant costs of each alternative.

	Lease and Make	Buy	Drop Thickness Gauge and Make
Total relevant costs	$	$	$

Answer 1

Make the subassembly
	Lease and Make	Buy	Drop thickness gauge and make
Total relevant costs	46,410	45,500	43,680
Margin lost on dropping thickness gauge = Segment Margin + Depreciation
=-3640+7280 = $3640
Hnece, drop thickness gauge and make