Make or Outsource Caselet

Make or Outsource Decision “In my opinion, we ought to stop making our own drums and accept outside supplier’s offer,” said Wim Niewindt, managing director of Antilles Refining, NV of Aruba (Aruba is a small island country in Southern Caribbean Sea; its currency is florin, denoted by fl.). “At a price of 18 fl. per drum, we would be paying 5 fl. Less then it costs us to manufacture the drum in our own plant. Since we use 60,000 drums a year that would be an annual cost saving of 300,000 fl.” Antilles Refining’s present cost to manufacture on drum is given below (based on 60,000 drums per year): Cost per Drum (fl.) Direct Material 10.35 Direct labour 6.00 Variable Overheads 1.50 Fixed Overheads 5.15 Total 23.00 The break-up of fixed overheads per drum is as follows: Depreciation of equipment Supervision General Company Overheads (allocated)

1.60 0.75 2.80

The 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: Alternative 1: Rent new equipment and continue to make the drum. The equipment would be rented at for fl. 135,000. Alternative 2: Purchase the drums from an outside supplier at fl. 18 per drum. The new rented equipment will be more efficient than the equipment Antilles Refining has been using to manufacture drums, and according to manufacturer of the equipment, it would reduce the direct labour and variable overhead costs by 30%. The capacity of the new equipment is 90,000 drums per year. Moreover, if company acquires this equipment on rent, it is not require providing for depreciation. The old equipment has no resale value. Supervision cost will remain unchanged if company decides to manufacture the drums on its own. The general company overheads would be unaffected by the decision; whatever alternative it choose.

Required: a. To assist the managing director in making the decision, prepare an analysis showing the total coat and cost per drum for each of the two alternatives given above. Which course of action would you recommend to the managing director? b. Would your recommendation in above be the same if company expects that it will need 90,000 drums from next year? Show computations to support your answer with cost presented on both a total and a per unit basis. c. What other factors would you recommend that the company consider before making decision?