Question

"In my opinion, we ought to stop making our own drums and accept that outside supplier’s offer," said Wim Niewindt, managing director of Antilles Refining, N.V., of Aruba. "At a price of $20 per drum, we would be paying $5.45 less than it costs us to manufacture the drums in our own plant. Since we use 80,000 drums a year, that would be an annual cost savings of $436,000." Antilles Refining’s current cost to manufacture one drum is given below (based on 80,000 drums per year):

Direct materials $ 12.00
Direct labor 6.50
Variable overhead 1.50
Fixed overhead ($2.90 general
company overhead, $1.80 depreciation,
and, $0.75 supervision) 5.45
Total cost per drum $ 25.45
A decision about whether to make or buy the drums is especially important at this time because the equipment being used to make the drums is completely worn out and must be replaced. The choices facing the company are:

Alternative 1: Rent new equipment and continue to make the drums. The equipment would be rented for $180,000 per year.

Alternative 2: Purchase the drums from an outside supplier at $20 per drum.

The new equipment would be more efficient than the equipment that Antilles Refining has been using and, according to the manufacturer, would reduce direct labor and variable overhead costs by 30%. The old equipment has no resale value. Supervision cost ($60,000 per year) and direct materials cost per drum would not be affected by the new equipment. The new equipment’s capacity would be 150,000 drums per year.

The company’s total general company overhead would be unaffected by this decision. (Round all intermediate calculations to 2 decimal places.)

Required:

1. Assuming that 80,000 drums are needed each year, what is the financial advantage (disadvantage) of buying the drums from an outside supplier?

2. Assuming that 100,000 drums are needed each year, what is the financial advantage (disadvantage) of buying the drums from an outside supplier?

3. Assuming that 150,000 drums are needed each year, what is the financial advantage (disadvantage) of buying the drums from an outside supplier?

(For all requirements, enter any "disadvantages" as a negative value. Do not round intermediate calculations.)

Answer 1

The financial advantage (disadvantage) of buying the drums from an outside supplier can be calculated by comparing the total cost of each alternative. For 80,000 drums, the financial advantage is $436,000. For 100,000 drums, the financial advantage is $545,000. For 150,000 drums, the financial advantage is $817,500.

Step-by-step explanation:

In this case, the financial advantage (disadvantage) of buying the drums from an outside supplier can be calculated by comparing the total cost of each alternative. Let's calculate it for each scenario:

1. For 80,000 drums needed each year:
   • Total cost of manufacturing 80,000 drums = 80,000 x $25.45 = $2,036,000
   • Total cost of buying 80,000 drums = 80,000 x $20 = $1,600,000
   • Financial advantage = Total cost of manufacturing - Total cost of buying = $2,036,000 - $1,600,000 = $436,000
2. For 100,000 drums needed each year:
   • Total cost of manufacturing 100,000 drums = 100,000 x $25.45 = $2,545,000
   • Total cost of buying 100,000 drums = 100,000 x $20 = $2,000,000
   • Financial advantage = Total cost of manufacturing - Total cost of buying = $2,545,000 - $2,000,000 = $545,000
3. For 150,000 drums needed each year:
   • Total cost of manufacturing 150,000 drums = 150,000 x $25.45 = $3,817,500
   • Total cost of buying 150,000 drums = 150,000 x $20 = $3,000,000
   • Financial advantage = Total cost of manufacturing - Total cost of buying = $3,817,500 - $3,000,000 = $817,500

Answer 2

The financial advantage of buying the drums from an outside supplier as compared to making them is $424,000 for 80,000 drums, $485,000 for 100,000 drums, and $637,500 for 150,000 drums annually.

Step-by-step explanation:

When deciding whether to make or buy the drums, Antilles Refining must analyze the cost savings and the potential financial advantages or disadvantages. To calculate the financial impact of each alternative, we must compare the current production cost against the cost of purchasing the drums.

For Alternative 1 (Rent new equipment):

1. Reduce direct labor and variable overhead by 30%: 6.50 × 0.7 = $4.55 direct labor; 1.50 × 0.7 = $1.05 variable overhead.
2. Total cost of producing one drum with the new equipment: $12.00 (materials) + $4.55 (labor) + $1.05 (variable overhead) + $5.45 (fixed overhead) = $23.05.
3. Add rental of new equipment divided by number of drums: $180,000 / 80,000 drums = $2.25 per drum.
4. Sum the per drum costs: $23.05 (production) + $2.25 (rental) = $25.30 total cost per drum.

For Alternative 2 (Purchase from supplier): $20.00 per drum.

The financial advantage or disadvantage can be calculated by subtracting the cost per drum of each alternative from the other.

Requirement 1: At 80,000 drums per year, the cost saving per drum when buying from a supplier: is $25.30 (make) - $20.00 (buy) = $5.30 savings per drum. Annual savings: $5.30 × 80,000 = $424,000.

Requirement 2: At 100,000 drums per year, the equipment cost per drum decreases: $180,000 / 100,000 drums = $1.80 per drum. Total cost per drum now: $23.05 + $1.80 = $24.85. Savings per drum: $24.85 (make) - $20.00 (buy) = $4.85. Annual savings: $4.85 × 100,000 = $485,000.

Requirement 3: At 150,000 drums per year, the equipment cost per drum is even less: $180,000 / 150,000 drums = $1.20 per drum. Total cost per drum: $23.05 + $1.20 = $24.25. Savings per drum: $24.25 (make) - $20.00 (buy) = $4.25. Annual savings: $4.25 × 150,000 = $637,500.