Eradicate, Inc. produces and sells a line of insect repellants that are sold primarily in the summer months. Recently, the chief operating officer has become interested in possibly manufacturing a repellant, "Halt" that can prevent a person from being attacked by use of a "pepper" repellant. The appeal of this product is that it would have year-round sales and would help stabilize the income of the company. The product, however, must be sold in a specially designed spray can the will be sold in cartons that hold 24 cans of the repellant. The sales price will be $96 per carton. The plant is now operating at only 65% of its total capacity, so no additional fixed costs will be incurred. However, a $100,000 fixed overhead charge will be allocated to the new product from the company's present total of fixed costs. Using the current estimates for 100,000 cartons of "Halt" as a standard volume, the following costs were developed for each carton, including the cost of the can:
Direct materials $12
Direct labor 6
Overhead (includes allocated fixed charge) 4
Total cost per carton $22
Eradicate, Inc., has requested a bid from a manufacturer of specialty dispensers for a purchase price of an empty can that could be used for the new product. The specialty company offered a price of $5 for a carton of cans. If the proposal is accepted, Eradicated, Inc., estimates that direct labor and variable overhead costs would be reduced by 10% and indirect material would be reduced by 20%.
1. Should Eradicate make or buy the special cans? (Hint: First compute the costs that could be saved by buying the cans.)
2. What would be the maximum purchase price acceptable to Eradicate for the cans?