Problem:
"That old equipment for producing subassemblies is worn out," said Kari Warner, president of Harleq Corporation. "We need to make a decision quickly." The company is trying to decide whether it should rent new equipment and continue to make its subassemblies internally or whether it should discontinue production of its subassemblies and purchase them from an outside supplier. The alternatives are as follows:
Alternative 1: New equipment for producing the subassemblies can be rented for $63,000 per year
Alternative 2: The subassemblies can be purchased from an outside supplier who has offered to provide them for $5.31 each under a five-year contract.
Harleq Corporation's present cost per unit for producing the subassemblies internally are given below. These costs are based on a current activity level of 50,000 sub assemblies per year:
Direct Materials........................$2.30
Direct Labor............................$1.90
Variable Overhead.........................$.40
Fixed Overhead ($.42 supervision, $.90 depreciation, and $1.75 general company overhead.........................$3.07
Total cost per unit.....................$7.67
The new equipment would be more efficient than the equipment Harleq Corporation has been using and according to the manufacturer, would reduce direct labor costs and variable overhead costs by 30%. The old equipment has no resale value. Supervision cost(21k per yr) and Direct materials cost per unit would not be affected by the new equipment. The new equipment's capacity would be 70,000 subassemblies per year. The company's total general company overhead would be unaffected by this decision.
Required to do:
1) To assist the president in making a decision, prepare an analysis showing the total cost and the cost per drum for each of the two alternatives given above. Assume that 50,000 subassemblies are needed each year. Which course of action would you recommend to the president?
2) Would your recommendation in (1) above be the same if the company's needs were (a) 60,000 subassemblies per year pr (b) 70,000 subassemblies per year? Show computations to support your answer with costs presented on both total and per unit basis.
3) What other factors would you recommend that the company consider before making a decision?