Procurement Question:

The new equipment would be more efficient and, according to the manufacturer, would reducedirect
labor costs and variable overhead costs by 25%. Supervision cost ($30,000 per year) anddirect materials
cost per unit would not be affected by the new equipment. The new equipment’scapacity would be
60,000 subassemblies per year.The total general company overhead would be unaffected by this
decision.

Required:

1. The president is unsure what the company should do and would like an analysis showing theunit costs
and total costs for each of the two alternatives given above. Assume that 40,000subassemblies are
needed each year. Which course of action would you recommend to thepresident?2. Would your
recommendation in (1) above be the same if the company’s needs were (

) 50,000subassemblies per year, or (

) 60,000 subassemblies per year?3. What other factors would you recommend that the company
consider before making adecision?

1) The analysis for the two alternatives

Differential Costs per Unit Total Differential Costs for 40,000 units

Make Buy Make Buy

Outside supplier's price $6 $240,000.00

Direct Materials$1.50 $60,000.00

Direct Labor ($3 x 0.75) $2.25 $90,000.00

Variable Overhead ($0.60 x .75) $0.45 $18,000.00

Supervision ($30,000 / 40,000) $0.75 $30,000.00

Equipment Rental ($60,000 / 40,000) $1.50 $60,000.00

Total $6.45 $6 $258,000.00 $240,000.00

The company should buy the subassemblies from outside supplier because of net saving of $0.45 per
unit.

2-a) Total relevant cost if produced internally for 50,000 subassemblies

Per unit Total for 50,000 units

Direct Materials$1.50 $75,000.00

Direct Labor ($3 x 0.75) $2.25 $112,500.00

Variable Overhead ($0.60 x .75) $0.45 $22,500.00

Supervision ($30,000 / 50,000) $0.60 $30,000.00

Equipment Rental ($60,000 / 50,000) $1.20 $60,000.00

Total $6.00 $300,000.00

2-b) Total relevant cost if produced internally for 60,000 subassemblies

Per unit Total for 60,000 units

Direct Materials$1.50 $90,000.00

Direct Labor ($3 x 0.75) $2.25 $135,000.00

Variable Overhead ($0.60 x .75) $0.45 $27,000.00

Supervision ($30,000 / 60,000) $0.50 $30,000.00

Equipment Rental ($60,000 / 60,000) $1.00 $60,000.00

Total $5.70 $342,000.00