Page 581 - Sensors and Control Systems in Manufacturing

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Cha p te r
Ele v e n

Variable costs
Materials per unit $2.00
Overhead costs per unit for the new activity (power, 0.75
suppliers, etc.)
Total variable cost per unit $2.75
Total variable cost per 10,000 units $27,500
Fixed costs
Salaries of 3 technicians (capable of producing 15,000 $21,000
units a year)
Depreciation on special machinery ($40,000 spread 8,000
over a 5-year life)
Total fixed costs for the new activity $29,000
Total costs
Total cost of producing 10,000 motors in plant $56,500
Total cost per unit $5.65

Thus, with a production level of 10,000 units a year, the manufac-
turing firm would be better off buying the motor from a supplier at
$4.80 each. However, with the three technicians and the $40,000 in
special equipment, it has the capacity to produce 15,000 motors a
year. At this level, its total cost would be $70,250 and its unit cost
$4.68. It would save at least $0.12 per unit, or $8750 over the five-year
useful life of the special equipment. So the decision to make or buy
the motor would depend on the volume needed.
On the other hand, the owner might decide that the $1750 a year
would not be enough to offset the extra burden that policing the
motor activity would place on key people. This assumes, of course,
that the present supplier delivers quality motors on time.
Another analysis is also involved in this decision, however—the
determination of whether the $8750 savings is enough to justify
investing $40,000 in special equipment, or whether the money could
be invested to better advantage elsewhere. This decision is known as
a capital budgeting decision.

11.2.7 The Importance of the Basic Data
The techniques of cost and profit analysis discussed earlier are
intended as guides. The validity of the method depends largely on
the validity of the basic data—the fixed and variable cost classifica-
tions, cost estimates, and volume estimates. Errors in any one of these
factors will cause mistakes in the computations and may result in
erroneous decisions.
Every manufacturing firm should continually review the way its
costs are classified and accumulated, and it should be very careful in