Case Scenario:
The president of JMorgan has equipment for producing subassemblies is worn out, the decision need to be made quickly, if the company 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
Alternatives:
1. Rent new equip for producing the subassemblies for $60,000 per year
2. Purchase subassemblies from an outside supplier for $8 each
The company present cost per unit of producing the subassemblies internally (with the old equipment) are given below. These costs are based on a current activity level of 40,000 subassemblies per year:
Direct materials $2.75
Direct labor 4.00
Variable overhead 60
Fixed overhead 3.65
($0.75 supervision, 0.90 depreciation, and $2 general company overhead)
Total cost per unit $11.00
The new equipment would be more efficient and would reduce direct labor cost and variable overhead cost by 25%. Supervision cost (30,000 per yr) and direct materials cost per unit would not be affected by the new equipment. The new equipment’s capacity would be 60,000 subassemblies per yr
1. The company leaders are not sure what the company should do and would like an analysis showing the unit cost and total cost for each of the 2 alternatives given above. Assume that 40,000 subassemblies are needed each year. Which course of action would you recommend to the leaders?
2. Would your recommendation above be the same if the company needs were (a) 50,000 subassemblies per yr, or (b) 60,000 subassemblies per yr? Show computations.
3. What other factors would you recommend that the company consider before making a decision?