The Tough Man Company manufactures forklift tractors and also sells some parts to other manufacturers of forklifts.
Question:
The Tough Man Company manufactures forklift tractors and also sells some parts to other manufacturers of forklifts. Tough Man produces most the component parts and purchases the engines, hydraulic systems, tires and wheels from other manufacturers.
Demand forecasts show that Tough Man should increase its production level from 60 forklift units monthly to 70 units monthly. The company has enough idle capacity in most of its departments to allow this increase, except that the production of 10 extra chassis assemblies could be attained only by reallocating labor and equipment from forklift-assembly manufacture to chassis-assembly manufacture.
The forklift-assembly manufacture department currently produces 90 units monthly and it sells the 30 surplus units to other manufacturers at $188 each. With the expanded production level, 70 forklifts would be required, but the labor and equipment responsible for the remaining 20 units is considered to be just sufficient to produce the 10 extra chassis assemblies.
Alternatively, the extra chassis assemblies could be purchased from an outside supplier and the best price available is $305 per unit.
The costs of the chassis and forklift departments for a representative month are as follows:
Costs ($)
Department
Chassis ($) Forklift ($)
Direct materials 4,650 2,070
Direct labor 6,300 4,050
Depreciation 750 500
Allocated overhead* 12,600 8,100
Total 24,300 14,720
Production level 60 90
*: natural gas, electricity, office etc.
Determine whether Tough Man should MAKE or BUY the 10 extra chassis assemblies. Explain your choice with calculations.
Variable unit cost of forklift = (2,070 + 4,050) / 90 = 68
Variable unit cost of chassis = (4,650 + 6,300) / 60 = 182.5
MAKE:
Stop selling 10 extra units of forklift:
Decrease in revenue = (10 × 188) = 1,880 [1]
Stop producing and selling 20 extra units of forklift:
Decrease in revenue = (20 × 188) = 3,760
Decrease in production cost = (20 × 68) = 1360
Net loss = 2,400 [2]
Production cost of 10 chassis: 10 × 182.5 = 1,825 [3]
Total cost of assembling the chassis at home = [1] + [2] +
[3] = 1,880 + 2,400 + 1,825 = 6,105
BUY:
Stop selling 10 extra units of forklift:
Decrease in revenue = (10 × 188) = 1,880 [1]
Purchase cost of 10 chassis = (10 × 305) = 3,050 [2]
Total cost of purchasing the chassis = [1] + [2] =
1,880 + 3,050 = 4,930
Tough Man should buy the chassis since it is a cheaper alternative.
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