Question 2
Powell Dentistry Services operates in a large metropolitan area. Currently Powell has its own dental laboratory to produce porcelain and gold crowns. The unit costs to produce the crowns are as follows:
Porcelain Gold
Raw materials $ 55 $ 94
Direct labour 22 22
Variable overhead 5 5
Fixed overhead 25 25
$ 107 $ 146
Fixed overhead is detailed as follows:
Salary (supervisor) $24,000
Amortization 5,000
Rent (lab facility) 26,000
Overhead is applied on the basis of direct labour hours. The unit costs above were computed using 5,500 direct labour hours.
A local dental laboratory has offered to supply Powell all the crowns it needs. Its price is $100 for porcelain crowns and $132 for gold crowns; however, the offer is conditional on supplying both types of crowns-it will not supply just one type for the price indicated. If the offer is accepted, the equipment used by Powell's laboratory would be scrapped (it is old and has no market value), and the lab facility would be closed. Powell uses 1,500 porcelain crowns and 1,000 gold crowns per year.
Required:
1. Should Powell continue to make its own crowns or should they be purchased from the external supplier? What is the dollar effect of purchasing? [4 marks]
2. What qualitative factors should Powell consider in making this decision? [2 marks]
3. Suppose that the lab facility is owned rather than rented and that the $26,000 is amortization rather than rent. What effect does this have on the analysis in Requirement 1? [2 marks