Textbook Problem

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Apollonia Dental Services is part of an HMO that operates in a large metropolitan area. Currently, Apollonia has its own dental laboratory to produce two varieties of porcelain crowns—all porcelain and porcelain fused to metal. The unit costs to produce the crowns are as follows:

Fixed overhead is detailed as follows:

Overhead is applied on the basis of direct labor hours. The rates above were computed using 8,000 direct labor hours. No significant non-unit-level overhead costs are incurred.

A local dental laboratory has offered to supply Apollonia all the crowns it needs. Its price is $265 for all-porcelain crowns and $145 for porcelain-fused-to-metal 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 Apollonia’s laboratory would be scrapped (it is old and has no market value), and the lab facility would be closed. Apollonia uses 2,500 all-porcelain crowns and 1,000 porcelain-fused-to-metal crowns per year.

Required:

1. 1. Should Apollonia continue to make its own crowns, or should they be purchased from the external supplier? What is the dollar effect of purchasing?
2. 2. What qualitative factors should Apollonia consider in making this decision?
3. 3. Suppose that the lab facility is owned rather than rented and that the $22,000 is depreciation rather than rent. What effect does this have on the analysis in Requirement 1?
4. 4. Refer to the original data. Assume that the volume of crowns is 5,000 all porcelain and 2,000 porcelain fused to metal. Should Apollonia make or buy the crowns? Explain the outcome.

To determine

Indicate whether Hospital A should make own crowns or buy from external supplier.

Explanation of Solution

Tactical decision making: Tactical decision making is a process in which the company can choose the correct alternative based on the profitability. In tactical decision making, offer price of a product is compared with the normal selling price and offer price less than the normal selling price of product is considered as the idle capacity for decision making.

Indicate whether Hospital A should make own crowns or buy from external supplier as follows:

Particulars	Make decision (B)	Buy decision (C)	Difference $\left(B-C\right)$
Direct materials (1)	$555,000	$0	$555,000
Direct labor (2)	$145,000	$0	$145,000
Variable overhead (3)	$67,500	$0	$67,500
Fixed overhead (5)	52,000	$0	$52,000
Purchase price (4)	$0	$807,500	($807,500)
Totals	$819,500	$807,500	$12,000

Table (1)

In this case, Hospital A should buy crowns from external suppliers because Hospital A can save $12,000 from buying decision.

Working note (1):

Calculate the direct material of Hospital A.

$\begin{array}{c}\text{Direct materials = }\left(\begin{array}{l}\left(\begin{array}{l}\text{Direct mateiral per crown}\times \\ \text{Number of all porcelain crowns}\end{array}\right)+\\ \left(\begin{array}{l}\text{Direct mateiral per crown}\times \\ \text{Number of porcelain fuset to metal crowns}\end{array}\right)\end{array}\right)\\ =\left(\$190\times 2,500\right)+\left(\$80\times 1,000\right)\\ =\$555,000\end{array}$

Working note (2):

Calculate the direct labor of Hospital A

To determine

State the qualitative factors associated with Hospital A’s decision making.

To determine

State the effects of equipment 1, if lab facility of Hospital A is owned rather than rented.

To determine

Indicate whether Hospital A should make own crowns or buy from external supplier if the volume of all porcelain crowns is 5,000 and volume of porcelain used to metal crowns is 2,000.