Q1. The Hyatt Company is trying to decide whether it should purchase new equipment and continue to make its subassemblies internally or if production should be discontinued and the subassembly purchased from an outside supplier. Either way production can not continue using the current equipment.
New equipment for producing the subassemblies can be purchased at a cost of $400,000. The equipment would have a five-year useful life (the company uses straight-line depreciation) and a $50,000 salvage value. Alternatively, the subassemblies could be purchased from an outside supplier. The supplier has offered to provide the subassemblies for $9 each under a five-year contract. Hyatt Company’s present costs per unit of producing the subassemblies internally (with the old equipment) are given below. The costs are based on a current activity level of 40,000 subassemblies per year:
Direct Materials
$ 3.00
Direct Labour
$ 4.20
Variable Overhead
$ 0.60
Fixed Overhead ($0.80 supervision, $0.90 depreciation,
and $2 general company overhead)
$ 3.70
Total Cost per Unit
$11.50
The new equipment would be more efficient and would reduce direct labour costs and variable overhead costs by 25%. Supervision cost ($30,000 per year) and direct materials cost per unit would not be affected by the new equipment. The company has no other use for the space now being used to produce the subassemblies. The company’s total general company overhead would not be affected by this decision. Assume direct labour is a variable cost. Required:
Assume that 40,000 subassemblies are needed each year. Prepare an analysis of the two alternatives and make a recommendation to the management of the company of the appropriate course of action.
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