Franklin Manufacturing Has Just Received an Offer from a Supplier

question 151

Essay

Franklin Manufacturing has just received an offer from a supplier to buy 12,000 units of a computerized component used in its main product. The component is currently produced internally. The supplier has offered to sell the component for $75 per unit. The estimated costs of producing it are given below:
Direct materials $30
Direct labour $15
Variable overhead $25
Fixed overhead $28
Prior to making a decision, the company's CEO commissioned a special study to see whether there would be any decrease in fixed overhead costs. The company would avoid two setups and that would reduce total spending by $10,000 per setup. One inspector would be laid off at a savings of $20,000. Janitorial services would be reduced by 200 hours at $15/hour. Although the work decreases by 200 hours, the janitor assigned to the computerized component line also spends time cleaning for other product lines and is guaranteed a 40 hour work week. Further, another department could use the area where this component is produced. That department is currently paying $90,000 to rent the same amount of space.
a)Ignore the special study and determine whether the gear should be produced internally or purchased from the supplier.
b)Now repeat the analysis using the special study data.
c)Briefly identify qualitative factors that might affect the decision, including strategic implications.

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Definitions:

Use of Funds

An explanation of how money will be spent, typically within a business or project framework.

Return on Equity

A measure of a company's profitability by revealing how much profit a company generates with the money shareholders have invested.

Return on Assets

A profitability ratio that indicates how efficiently a company is using its assets to generate earnings.

Return on Sales

A financial ratio that calculates how efficiently a company is generating profits from its revenue, typically expressed as a percentage of sales revenue that turns into net income.