“In my opinion, we ought to stop making our own drums and accept that outside supplier’s offer,” saidWim Niewindt, managing director of Antilles Refining, N.V., of Aruba. “At a price of 18 florins per drum,we would be paying 5 florins less than it costs us to manufacture the drums in our own plant. (The currencyin Aruba is the florin, denoted below by fl.) Because we use 60,000 drums a year, that would be an annualcost savings of 300,000 florins.” Antilles Refining’s present cost to manufacture one drum is given below(based on 60,000 drums per year):Direct materials ...................................................................... fl10.35Direct labor ............................................................................. 6.00Variable overhead .................................................................. 1.50Fixed overhead (fl2.80 general companyoverhead, fl1.60 depreciation and,fl0.75 supervision) ........................................................... 5.15Total cost per drum ................................................................ fl23.00A decision about whether to make or buy the drums is especially important at this time because theequipment being used to make the drums is completely worn out and must be replaced. The choices facingthe company are:Alternative 1: Rent new equipment and continue to make the drums. The equipment would be rented forfl135,000 per year.Alternative 2: Purchase the drums from an outside supplier at fl18 per drum.The new equipment would be more efficient than the equipment that Antilles Refining has beenusing and, according to the manufacturer, would reduce direct labor and variable overhead costs by 30%.The old equipment has no resale value. Supervision cost (fl45,000 per year) and direct materials cost perdrum would not be affected by the new equipment. The new equipment’s capacity would be 90,000 drumsper year.The company’s total general company overhead would be unaffected by this decision.Required:1. To assist the managing director in making a decision, prepare an analysis showing the total cost and thecost per drum for each of the two alternatives given above. Assume that 60,000 drums are needed eachyear. Which course of action would you recommend to the managing director?2. Would your recommendation in (1) above be the same if the company’s needs were: (a) 75,000drums per year or (b) 90,000 drums per year? Show computations to support your answer, with costspresented on both a total and a per unit basis.3. What other factors would you recommend that the company consider before making a decision?
“In my opinion, we ought to stop making our own drums and accept that outside supplier’s offer,” said
Wim Niewindt, managing director of Antilles Refining, N.V., of Aruba. “At a price of 18 florins per drum,
we would be paying 5 florins less than it costs us to manufacture the drums in our own plant. (The currency
in Aruba is the florin, denoted below by fl.) Because we use 60,000 drums a year, that would be an annual
cost savings of 300,000 florins.” Antilles Refining’s present cost to manufacture one drum is given below
(based on 60,000 drums per year):
Direct materials ...................................................................... fl10.35
Direct labor ............................................................................. 6.00
Variable overhead .................................................................. 1.50
Fixed overhead (fl2.80 general company
overhead, fl1.60
fl0.75 supervision) ........................................................... 5.15
Total cost per drum ................................................................ fl23.00
A decision about whether to make or buy the drums is especially important at this time because the
equipment being used to make the drums is completely worn out and must be replaced. The choices facing
the company are:
Alternative 1: Rent new equipment and continue to make the drums. The equipment would be rented for
fl135,000 per year.
Alternative 2: Purchase the drums from an outside supplier at fl18 per drum.
The new equipment would be more efficient than the equipment that Antilles Refining has been
using and, according to the manufacturer, would reduce direct labor and variable overhead costs by 30%.
The old equipment has no resale value. Supervision cost (fl45,000 per year) and direct materials cost per
drum would not be affected by the new equipment. The new equipment’s capacity would be 90,000 drums
per year.
The company’s total general company overhead would be unaffected by this decision.
Required:
1. To assist the managing director 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 60,000 drums are needed each
year. Which course of action would you recommend to the managing director?
2. Would your recommendation in (1) above be the same if the company’s needs were: (a) 75,000
drums per year or (b) 90,000 drums per year? Show computations to support your answer, with costs
presented on both a total and a per unit basis.
3. What other factors would you recommend that the company consider before making a decision?
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