Problem 12-28 Make or Buy Decisions [LO12-3]

“In my opinion, we ought to stop making our own drums and acceptthat outside supplier’s offer,” said Wim Niewindt, managingdirector of Antilles Refining, N.V., of Aruba. “At a price of $21per drum, we would be paying $7.05 less than it costs us tomanufacture the drums in our own plant. Since we use 65,000 drums ayear, that would be an annual cost savings of $458,250.” AntillesRefining’s current cost to manufacture one drum is given below(based on 65,000 drums per year):

Direct materials	$	10.70
Direct labor		9.50
Variable overhead		1.50
Fixed overhead ($3.50 general company overhead, $1.95 depreciation, and, $0.90 supervision)		6.35
Total cost per drum	$	28.05

A decision about whether to make or buy the drums is especiallyimportant at this time because the equipment being used to make thedrums is completely worn out and must be replaced. The choicesfacing the company are:

Alternative 1: Rent new equipment and continue to make thedrums. The equipment would be rented for $175,500 per year.

Alternative 2: Purchase the drums from an outside supplier at$21 per drum.

The new equipment would be more efficient than the equipmentthat Antilles Refining has been using and, according to themanufacturer, would reduce direct labor and variable overhead costsby 30%. The old equipment has no resale value. Supervision cost($58,500 per year) and direct materials cost per drum would not beaffected by the new equipment. The new equipment’s capacity wouldbe 130,000 drums per year.

The company’s total general company overhead would be unaffectedby this decision. (Round all intermediate calculations to 2 decimalplaces.)

Required:

1. Assuming that 65,000 drums are needed each year, what is thefinancial advantage (disadvantage) of buying the drums from anoutside supplier?

2. Assuming that 90,000 drums are needed each year, what is thefinancial advantage (disadvantage) of buying the drums from anoutside supplier?

3. Assuming that 130,000 drums are needed each year, what is thefinancial advantage (disadvantage) of buying the drums from anoutside supplier?