@ 2012, Cengage Learning Differential Analysis, Product Pricing, and Activity-Based Costing LO 1c – Make or Buy Decisions and Replace Equipment Decisions

Make or Buy  Companies often manufacture products made up of components that are assembled into a final product. Should they make or buy the parts? LO 1

 If the make price of $280 is simply compared with the buy price of $240, the decision is to buy the instrument panel shown on the next slide. However, there are more factors to consider. Exhibit 7 on Slide 5 considers relevant costs in making this decision. LO 1 Make or Buy

An automobile manufacturer has been purchasing instrument panels for $240 a unit. The factory currently operates at 80% of capacity. The cost per unit of manufacturing a panel internally is estimated as follows: Direct materials$ 80 Direct labor80 Variable factory overhead52 Fixed factory overhead 68 Total estimated cost per unit$280 LO 1

Make or Buy LO 1

Replace Equipment On November 28, 2012, a business is considering replacing the following machine: Old Machine: Book value$100,000 Estimated annual variable manufacturing costs225,000 Estimated selling price25,000 Estimated remaining useful life5 years (continued) LO 1

Replace Equipment The business is considering replacing the old machine with a new one, as shown below: Old New Book value$100,000 Cost of new machine$250,000 Estimated annual variable manufacturing costs225,000150,000 Estimated selling price25,000 Estimated residual value0 Estimated remaining useful life5 years5 years (continued) LO 1

Replace Equipment LO 1 replace old machine

Replace Equipment  The revenue that is forgone from an alternative use of an asset, such as cash, is called an opportunity cost.  Although the opportunity cost is not recorded in the accounting records, it is useful in analyzing alternative courses of action. LO 1

Replace Equipment  Assume that the cash outlay of $250,000 for the new equipment, less the $25,000 proceeds from the sale of the present equipment, could be invested to yield a 10% return. Thus, the annual opportunity cost related to the purchase is $22,500 (10% * $225,000). LO 1