Total cost of 80,000 pistons ……………………………………….. $480,000 — Creed Corporation considering manufacturing new engine designated model VX4 The will different

Creed Corporation is considering manufacturing a new engine designated as model VX4. The engine will be a different size from any produced by Creed, and the company expects to sell 20,000 units a year. At the present time the company has the capacity to produce the projected quantity of all of the parts required for 20,000 units of VX4 except for the pistons. Each model VX4 engine requires 4 pistons, so 80,000 pistons will be required annually. Pistons are manufactured in the company's Tuscon plant, which is presently operating at full capacity. None of the company's other plants has the equipment or the expertise necessary to manufacture pistons. To manufacture the number of pistons required, the company can expand facilities at the Tuscon plant by renting additional machinery at an annual cost of $30,000 and hiring an additional supervisor at an annual cost of $40,000. Alternatively, the company can purchase the required number of pistons of equal quality from Wichita Machine Works, an outside supplier, at a contract price of $4.40 each. The projected cost of manufacturing 80,000 pistons at the Tuscon plant is as follows:

Direct materials …………………………………………………….. $160,000

Direct labor ………………………………………………………… 80,000

Allocated factory overhead ……………………………………….. 240,000

Total cost of 80,000 pistons ……………………………………….. $480,000

The Tuscon plant uses a predetermined factory overhead rate computed on the basis of absorption costing. Budgeted factory overhead used as the basis for determining the rate was composed of 80% fixed cost and 20% variable cost.

Required:

Determine whether Creed Corporation should manufacture the pistons in its Tuscon plant or purchase them from Wichita Machine Works.

SOLUTION

The company should purchase the pistons from the outside supplier because it would cost $6,000 less than manufacturing them at the Tucson plant.

The differential cost of manufacturing pistons at the Tucson plant:

Direct materials........................................................... $160,000