Density Gauge Thickness Gauge Total Sales Less variable expenses Contribution margin Less direct fixed expenses* Segment margin Less common fixed expenses Operating income S150,000 80,000 S80,000 $230,000 126,000 $104,000 46,000 S 70,000 20,000 S34,000 38,000 58,000 S 50,000 S (4,000) $ 46,000 30,000 $ 16,000 *Includes depreciation.
Morrill Company produces two different types of gauges: a density gauge and a thickness gauge.
The segmented income statement for a typical quarter follows.
The density gauge uses a subassembly that is purchased from an external supplier for $25 per
unit. Each quarter, 2,000 subassemblies are purchased. All units produced are sold, and there
are no ending inventories of subassemblies. Morrill is considering making the subassembly
rather than buying it. Unit-level variable
Direct materials $2
Direct labor 3
Variable
No significant non-unit-level costs are incurred.
Morrill is considering two alternatives to supply the productive capacity for the subassembly.
1. Lease the needed space and equipment at a cost of $27,000 per quarter for the space and
$10,000 per quarter for a supervisor. There are no other fixed expenses.
2. Drop the thickness gauge. The equipment could be adapted with virtually no cost and the
existing space utilized to produce the subassembly. The direct fixed expenses, including
supervision, would be $38,000, $8,000 of which is depreciation on equipment. If the thick-
ness gauge is dropped, sales of the density gauge will not be affected.
Required:
1. Should Morrill Company make or buy the subassembly? If it makes the subassembly, which
alternative should be chosen? Explain and provide supporting computations.
2. Suppose that dropping the thickness gauge will decrease sales of the density gauge by 10
percent. What effect does this have on the decision?
3. Assume that dropping the thickness gauge decreases sales of the density gauge by 10 percent
and that 2,800 subassemblies are required per quarter. As before, assume that there are no
The density gauge uses a subassembly that is purchased from an external supplier for $25 per
unit. Each quarter, 2,000 subassemblies are purchased. All units produced are sold, and there
are no ending inventories of subassemblies. Morrill is considering making the subassembly
rather than buying it. Unit-level variable manufacturing costs are as follows:
Direct materials $2
Direct labor 3
Variable overhead 2
No significant non-unit-level costs are incurred.
Morrill is considering two alternatives to supply the productive capacity for the subassembly.
1. Lease the needed space and equipment at a cost of $27,000 per quarter for the space and
$10,000 per quarter for a supervisor. There are no other fixed expenses.
2. Drop the thickness gauge. The equipment could be adapted with virtually no cost and the
existing space utilized to produce the subassembly. The direct fixed expenses, including
supervision, would be $38,000, $8,000 of which is depreciation on equipment. If the thick-
ness gauge is dropped, sales of the density gauge will not be affected.
Required:
1. Should Morrill Company make or buy the subassembly? If it makes the subassembly, which
alternative should be chosen? Explain and provide supporting computations.
2. Suppose that dropping the thickness gauge will decrease sales of the density gauge by 10
percent. What effect does this have on the decision?
3. Assume that dropping the thickness gauge decreases sales of the density gauge by 10 percent
and that 2,800 subassemblies are required per quarter. As before, assume that there are no ending inventories of subassemblies and that all units produced are sold. Assume also that the per-unit sales price and variable costs are the same as in Requirement 1. Include the leasing alternative in your consideration. Now, what is the correct decision?
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