That old equipment for producing subassemblies is worn out, said Paul Taylor, president of Timkin Company. 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 follow:
| Alternative 1: |
Rent new equipment for producing the subassemblies for $60,000 per year. |
| Alternative 2: |
Purchase subassemblies from an outside supplier for $9 each. |
|
Timkin Companys current costs per unit of producing the subassemblies internally are given below. These costs are based on a current activity level of 40,000 subassemblies per year:
|
|
|
|
| Direct materials |
$ |
2.44 |
| Direct labor |
|
5.00 |
| Variable overhead |
|
0.60 |
Fixed overhead ($0.75 supervision, $0.80 depreciation,
and $2 general company overhead) |
|
3.55 |
|
|
|
| Total cost per unit |
$ |
11.59 |
|
|
|
|
|
The new equipment would be more efficient and, according to the manufacturer, would reduce direct labor costs and variable overhead costs by 15%. Supervision cost 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 year.
|
The total general company overhead would be unaffected by this decision.