"In my opinion, we ought to stop making our own drums and accept that outside supplier's offer," said Wim Niewindt, managing director of Antilles Refining, N.V., of Aruba. "At a price of 17 florins per drum, we would be paying 7.11 florins less than it costs us to manufacture the drums in our own plant. Because we use 41,000 drums a year, that would be an annual cost savings of 291,510 florins." Antilles Refining's present cost to manufacture one drum is given below.
- Direct materials fl 11.05
- Direct labor 6.60
- Variable overhead 1.60
- Fixed overhead (fl2.40 general company overhead,
- fl1.56 depreciation and, fl0.90 supervision) 4.86
- Total cost per drum
- fl 24.11
A decision about whether to make or buy the drums is especially important at this time because 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 drums. The equipment would be rented for fl144,900 per year.
Alternative 2: Purchase the drums from an outside supplier at fl17 per drum.
The new equipment would be more efficient than the equipment that Antilles Refining has been using and, according to the manufacturer, would reduce direct labor and variable overhead costs by 15%. The old equipment has no resale value. Supervision cost (fl36,900 per year) and direct materials cost per drum would not be affected by the new equipment. The new equipment's capacity would be 108,000 drums per year.
The company's total general company overhead would be unaffected by this decision.