What qualitative factors should Gray consider in making this decision? 1 answer below »

MAKE-OR-BUY, FUNCTIONAL-BASED ANALYSIS, QUALITATIVE CONSIDERATIONS

Gray Dentistry Services is part of an HMO that operates in a large metropolitan area. Currently, Gray has its own dental laboratory to produce porcelain and gold crowns.

The unit costs to produce the crowns are as follows:

 

Porcelain

Gold

Direct materials

$ 60

$ 90

Direct labor

20

20

Variable overhead

5

5

Fixed overhead

22

22

Total

$107

$137

Fixed overhead is detailed as follows:

Salary (supervisor)

$30,000

Depreciation

5,000

Rent (lab facility)

20,000

 Overhead is applied on the basis of direct labor hours. The rates above were computed using 5,500 direct labor hours. No significant non-unit-level overhead costs are incurred.

A local dental laboratory has offered to supply Gray all the crowns it needs. Its price is $100 for porcelain crowns and $132 for gold crowns; however, the offer is conditional on supplying both types of crowns—it will not supply just one type for the price indicated. If the offer is accepted, the equipment used by Gray’s laboratory would be scrapped (it is old and has no market value), and the lab facility would be closed. Gray uses 1,500 porcelain crowns and 1,000 gold crowns per year.

Required:

1. Should Gray continue to make its own crowns, or should they be purchased from the external supplier? What is the dollar effect of purchasing?

2. What qualitative factors should Gray consider in making this decision?

3. Suppose that the lab facility is owned rather than rented and that the $20,000 is depreciation rather than rent. What effect does this have on the analysis in Requirement 1?

4. Refer to the original data. Assume that the volume of crowns is 3,000 porcelain and 2,000 gold. Should Gray make or buy the crowns? Explain the outcome.

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