The Hyatt Company Is Trying To Decide Whether It Should Purc ✓ Solved

The Hyatt Company Is Trying To Decide Whether It Should Purchase N

Q1. The Hyatt Company is trying to decide whether it should purchase new equipment and continue to make its subassemblies internally or if production should be discontinued and the subassembly purchased from an outside supplier. Either way production can not continue using the current equipment. New equipment for producing the subassemblies can be purchased at a cost of $400,000. The equipment would have a five-year useful life (the company uses straight-line depreciation) and a $50,000 salvage value.

Alternatively, the subassemblies could be purchased from an outside supplier. The supplier has offered to provide the subassemblies for $9 each under a five-year contract. Hyatt Company's present costs per unit of producing the subassemblies internally (with the old equipment) are given below. The costs are based on a current activity level of 40,000 subassemblies per year: Direct Materials $3.00, Direct Labour $4.20, Variable Overhead $0.60, Fixed Overhead ($0.80 supervision, $0.90 depreciation, and $2.00 general company overhead) $3.70, Total Cost per Unit $11.50. The new equipment would be more efficient and would reduce direct labour costs and variable overhead costs by 25%. Supervision cost ($30,000 per year) and direct materials cost per unit would not be affected by the new equipment. The company has no other use for the space now being used to produce the subassemblies. The company's total general company overhead would not be affected by this decision. Assume direct labour is a variable cost.

Required: Assume that 40,000 subassemblies are needed each year. Prepare an analysis of the two alternatives and make a recommendation to the management of the company of the appropriate course of action.

Sample Paper For Above instruction

Analysis of Make or Buy Decision for Hyatt Company

Hyatt Company's decision to either manufacture subassemblies in-house or purchase them externally hinges on a detailed cost analysis comparing the ongoing costs of each option. This analysis considers the costs associated with acquiring new equipment versus the costs of outsourcing, alongside any relevant fixed and variable costs and potential savings stemming from operational efficiencies.

Cost of Internal Manufacturing

Initially, the company's current per-unit manufacturing cost amounts to $11.50. This includes direct materials ($3.00), direct labour ($4.20), variable overhead ($0.60), and fixed overhead totaling $3.70 per unit. Since fixed overhead costs are often sunk or unavoidable in the short term, their relevance will be considered accordingly.

With the introduction of the new equipment, certain costs would decrease. The new equipment would lead to a 25% reduction in direct labour costs and variable overheads. Specifically, the labor cost would decrease from $4.20 to $3.15, and variable overhead would decrease from $0.60 to $0.45, saving $1.05 and $0.15 per unit, respectively. The fixed supervision cost of $30,000 annually remains unchanged, and supervision costs are fixed by the company's operations, thus not directly affected by the decision at the activity level.

Cost of External Purchase

Alternatively, purchasing the subassemblies at $9 per unit over five years totals $45 per unit. Since this is a fixed contracted rate, it can be directly compared against the internal manufacturing costs including any relevant savings or additional expenditures.

Cost Comparison and Analysis

Calculating the annual costs for manufacturing with new equipment:

• Direct materials: $3.00 per unit, no change.
• Direct labour: $3.15 per unit (after 25% reduction in costs).
• Variable overhead: $0.45 per unit (after 25% reduction).
• Total variable costs per unit: $3.00 + $3.15 + $0.45 = $6.60.
• Total variable costs for 40,000 units: 40,000 x $6.60 = $264,000.

The fixed supervision cost of $30,000 remains unchanged. Therefore, the total annual manufacturing cost with new equipment is:

• Variable costs: $264,000
• Fixed supervision: $30,000
• Total manufacturing costs: $294,000

Cost of purchasing externally over five years:

• 40,000 units per year x $9 = $360,000 annually.

Over five years:

• Internal manufacturing total: 5 x $294,000 = $1,470,000.
• External purchase total: 5 x $360,000 = $1,800,000.

Additional Considerations

Moreover, the initial investment in new equipment is $400,000, with a salvage value of $50,000 at the end of five years. The annual depreciation expense for the equipment would be:

($400,000 - $50,000) / 5 = $70,000 per year.

While depreciation is a non-cash expense, it helps to assess the cash flow impact of the investment. The relevant cash flows include the initial outlay of $400,000, annual operating savings of ($294,000 - $360,000) = -$66,000, indicating a cost increase unless other benefits or savings are considered.

Decision and Recommendation

Considering the above analysis, manufacturing internally with new equipment results in higher costs compared to outsourcing, primarily driven by the purchase price of external subassemblies. However, non-financial factors such as quality control, supplier reliability, and capacity constraints also influence decision-making.

Since internal manufacturing costs are lower than the external purchase cost by approximately $66,000 annually, and considering the total investment in new equipment, Hyatt should further evaluate whether additional strategic benefits justify the higher outsourcing cost. If cost savings are paramount, continuing to produce internally with new equipment appears advantageous.

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