Henderson Company produces two products, A and B. The segmented income statement for a typical quarter follows:
|
Product A
|
Product B
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Total
|
|
Sales
|
$150,000
|
$80,000
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$230,000
|
|
Less: Variable expenses
|
80,000
|
46,000
|
126,000
|
|
Contribution margin
|
$ 70,000
|
$34,000
|
$104,000
|
|
Less: Direct fixed expenses*
|
20,000
|
38,000
|
58,000
|
|
Segment margin
|
$ 50,000
|
$ (4,000)
|
$ 46,000
|
|
Less: Common fixed expenses
|
|
|
30,000
|
|
Operating income
|
|
|
$ 16,000
|
* Includes depreciation.
Product A uses a subassembly that is purchased from an external supplier for $25 per unit. Each quarter, 2,000 subassemblies are purchased. All units produced are sold, and there are no ending inventories of subassemblies. Henderson is consid- ering making the subassembly rather than buying it. Unit variable manufacturing costs are as follows:
|
Direct materials
|
$2
|
|
Direct labor
|
3
|
|
Variable overhead
|
2
|
Two alternatives exist to supply the productive capacity:
1. Lease the needed space and equipment at a cost of $27,000 per quarter for the space and $10,000 per quarter for a supervisor. No other fixed expenses are incurred.
2. Drop Product B. 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 $38,000, $8,000 of which is depreciation on equipment. If Product B is dropped, the sales of Product A will not be affected.
Required
1. Should Henderson Company make or buy the subassembly? If it makes the subassembly, which alternative should be chosen? Explain and provide supporting computations.
2. Suppose that dropping B will decrease sales of A by 6 percent. What effect does this have on the decision?
3. Assume that dropping B decreases sales of A by 6 percent and that 2,800 subassemblies are required per quarter. As before, assume that there are no ending inven- tories of subassemblies and that all units produced are sold. Assume also that the per-unit sales price and variable costs are the same as in Requirement 1. Include the leasing alternative in your consideration. Now, what is the correct decision?