The Pastel Company must reach a make/buy decision with respect to a high volume, easily made metal tool, RG1. Sean Gray, the cost analyst, estimates the following costs and production information for the 50,000 units of RG1 that are expected to be put into production.
Total direct materials costs ................. $660,000
Direct manufacturing labour costs (all variable) ......... $220,000
Manufacturing overhead costs (all fixed) ............ $440,000
Good units of RG1 manufactured and sold .......... 40,000 units
Units of RG1 scrapped for zero revenue ........... 10,000 units
York Corporation has offered to supply as many units of RG1 as Pastel needs for $23.10per unit. If Pastel buys RG1 from York instead of manufacturing it in-house, Pastel would be able to save $263,450 of the $440,000 fixed manufacturing overhead costs. (There is no alter-native use for the capacity currently used to make RG1.)Gray shows his analysis to Jim Berry, the controller. Berry does not like what he sees. He asks Gray to review all his assumptions and calculations, commenting, “The yield assumptions you made are very low. I think this plant can achieve much better quality than we have in the past. Better quality will reduce our costs and make them competitive with the outside purchase price.” Gray knows that Berry is very concerned about purchasing RG1 from an outside supplier because it will mean that some of his close friends who work on the RG1 line will be laid off. Berry had played a key role in convincing management to produce RG1 in-house. Gray rechecks his calculations. He believes it is unlikely that the plant can achieve the quality levels it would take for the make alternative to be superior to the buy alternative.
1. Based on the information Gray obtains, should Pastel make or buy RG1?
2. For what levels of scrap would the make alternative be preferred to purchasing from out-side?
3. Evaluate whether Jim Berry’s suggestion to Gray to review his estimates is unethical. Will it be unethical for Gray to change his analysis to support the make alternative? What steps should Gray take next?