Question

"That old equipment for producing carburetors is worn out," said Bill Seebach, president of Hondrich Company. "We need to make a decision quickly." The company is trying to decide whether it should rent new equipment and continue to make its carburetors internally or whether it should discontinue production of its carburetors and purchase them from an outside supplier. The alternatives follow: Alternative 1: Rent new equipment for producing the carburetors for $115,000 per year. Alternative 2: Purchase carburetors from an outside supplier for $16.95 each Hondrich Company's costs per unit of producing the carburetors internally (with the old equipment) are given below. These costs are based on a current activity level of 25,000 units per year: $5.10 Direct materials Direct labour Variable overhead 8.00 2.80 Fixed overhead ($2.30 supervision, $1.80 depreciation, and $4.00 general company overhead) 8.10 Total cost per unit $24.00 The new equipment would be more efficient and, according to the manufacturer, would reduce direct labour costs and variable overhead costs by 25%. Supervision cost ($57,500 per year) and direct materials cost per unit would not be affected by the new equipment. The new equipment's capacity would be 50,000 carburetors per year. The total general company overhead would be unaffected by this decision.

Answer 1

1.Relevanct cost of manufacturing = Avoidable cost

= (5.10+8*75%+2.80*75%)*25,000 + 57,500 +115,000

= $502,500

Per unit cost = 502500/25000 = $20.1

c.Purchase from outside supplier since lower cost

a-1 Cost = 13.2*46000 + 57500+115,000

= $779,700

Per unit = $16.95

Indifferent

b-1 Total cost = $832,500

Per unit = $16.65

Manufacture internally