Question 3 Danford Company a manufacturer of farm equipment

Question 3 Danford Company, a manufacturer of farm equipment, currently produces 20,000 units of gas filters per year for use in its lawn-mower production. The costs, based on the previous year\'s production, are reported in the table below Item Direct Materials Direct Labour Variable Overhead (power and water) Fixed Overhead (light and heat) Total Cost Expense ($) $ 60,000 180,000 135,000 70,000 445,000 It is anticipated that gas-filter production will last five years. If the company continues to produce the product in-house, annual material costs will increase at the rate of 5% (for example, annual material costs during the first production year will be $63,000) direct labour will also increase at the rate of 6% per year. However, variable overhead costs will increase at the rate of 3% but the fixed overhead will remain at its current level over the next five years John Holland Company has offered to sell Danford 20,000 units of gas filters for $25 per unit. If Danford accepts the offer, some of the manufacturing facilities currently used to manufacture the filter could be rented to a third party for $35,000 per year. In addition, $3.5 per unit of the fixed overhead applied to the production of gas filters would be eliminated. The firm\'s interest rate is known to be 15%. What is the unit cost of buying the gas filter from the outside source? Should Danford accept John Holland\'s offer, and why?

Solution

Solution:

Alternative 1: Purchasing units from John Holland

Cost per unit: $25 - ($35,000) / 20,000 = $23.25

Alternative 2: Making units in house

PW(15%)dm = $63,000 (PA, 5%,15%,5) = $230,241

PW(15%)dt = $190,800 (PA, 6%,15%,5) = $709,491

PW(15%)vo = $139,050 (PA, 3%,15%,5) = $490,888

AEC(15%) = $230,241 + $709,491 + $490,888 + (A/P,15%,5) + 70,000 = $496,776

Cost per unit= $496,776 / 20,000 = $24.84

?

Since alternative 1 unit cost is lesser, thus select option 1