The ABC Company recently started producing a new product, in addition to two others it has been
Question:
The ABC Company recently started producing a new product, in addition to two others it has been producing for several years. One of the major parts of this new product now is being purchased from another company at a cost of $7.00 per unit. One of the officers of the ABC Company believes it would be advisable to purchase the required equipment, at a cost of $7,000 that would permit making this component. This equipment would have a capacity of 7,000 units per year and a useful life of at least 5 years. It could be installed in the existing plant provided a small storage shed were built at a cost of $2,000 to make the necessary floor space available. Material costs would be $1.10 per unit, and direct labor costs of $2.40 per unit. Incremental overhead of 50% of direct labor cost. There would also have to be an added annual charge of 2% of the first cost of the storage shed to cover taxes and insurance. The company now is purchasing 4,000 of the parts per year.
a) If capital is worth 15%, should the part be purchased or made in the plant?
b) What volume would be required to justify purchasing the equipment? Use the annual worth method.
Management Accounting Information for Decision-Making and Strategy Execution
ISBN: 978-0137024971
6th Edition
Authors: Anthony A. Atkinson, Robert S. Kaplan, Ella Mae Matsumura, S. Mark Young