Nov 2014

CASE 1
Scenario

Tecmac Companys old machine for making subassemblies is worn out. The company is
considering two courses of action:
1)
2)

Completely replacing the old machine with new machine

Buying subassemblies from a reliable outside supplier, who has quoted a unit price of
$1 on a seven-year contract for a minimum of 50,000 units of subassembly a year.

Production was 60,000 subassemblies in each of the past 2 years. Future needs for the next 7
years are expected to fluctuate between 50,000 to 70,000 subassemblies per year. Cost
records for the past 2 years reveal the following unit costs of manufacturing the subassembly:
Direct materials
$0.30
Direct labour
0.35
Variable factory overhead
0.10
Fixed factory overhead
(includes $0.10 depreciation and $0.10 for direct departmental fixed overhead) 0.25
Total cost
$1.00
The new machine will cost $188,000 cash, will last 7 years, and will have a scrap value of
$20,000. The current disposal value of the old machine is $10,000.
The sales representative of the new machine has summarized the following details relating to
the new machine:
1. The increase in machine speeds will reduce direct labour and variable overhead by
$0.35 per unit.
2. Based on last year experience of one of your major competitors with identical
machine:
They produced 100,000 subassemblies under operating conditions very
comparable to yours and showed the following unit costs.
Direct materials
$0.30
Direct labour
0.05
Variable factory overhead
0.05
Fixed factory overhead (includes depreciation of $0.24 ) 0.40
Total
$0.80
For the purpose of this case, assume that any idle facilities cannot be put to alternative use.
Also assume that $0.05 of Tecmacs unit cost is allocated fixed overhead that will be
unaffected by the decision.

School of Business/A&F/CMA2 Assignment

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Nov 2014

CASE 1
Required:
a)

The general manager asks you to compare the alternatives on a total-annual-cost basis
and on a per-unit basis for annual needs of 60,000 subassemblies. Which alternative
seems more attractive?
(10 marks)

b)

i) Would your answer to part a) change if the needs were 70,000 units of subassembly?
ii) At what volume level would Tecmac be indifferent between making and buying the
subassemblies?
Show all computations.
(10 marks)

c)

What qualitative factors should the accountant bring to the attention of management to
assist them in making their decision? Include the consideration that might be applied to
the outside supplier.
(5 marks)

School of Business/A&F/CMA2 Assignment

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