Problem 9-7 Preparing a Make-or-Buy Analysis and Making an Equipment Replacement Decision (LO1 CC2, 4) "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 144 florins per drum, we would be paying 10 florins less than it costs us to manufacture the drums in our own plant. (The currency in Aruba is the florin, denoted by Afl.) Since we use 380,000 drums a year, we would save 3,800,000 florins on an annual basis." Antilles Refining's present cost to manufacture one drum follows (based on 380,000 drums per year) Direct material Direct labour Variable overhead Fixed overhead (Af123.60 general Afl 38.70 30.00 21.00 company overhead, Af121.20 depreciation and, Af19.50 supervision) 64.30 Total cost per drum Afl 154.00 A decision about whether to make or buy the drums is especially important at this time, since the equipment being used to make the drums is completely worn out and must be replaced. The choices facing the company are as follows Alternative 1: Purchase new equipment and continue to make the drums. The equipment would cost Afl5,130,000; it would have a six-year useful life and no salvage value. The company uses straight-line depreciation Alternative 2: Purchase the drums from an outside supplier at Afl144 per drum under a six-year contract. The new equipment would be more efficient than the equipment that Antilles Refining has been using and, according to the manufacturer, would reduce direct labour and variable overhead costs by 30%. The old equipment has no resale value. Supervision cost (Afl7,410,000 per year) and direct materials cost per drum would not be affected by the new equipment. The new equipment's capacity would be 7,410,000 drums per year. The company has no other use for the space being used to produce the drums