Question

Choose one case below to evaluate. Without using the textbook or referring to the videos, decide what would be the best course of action. Make sure you identify what case you are addressing and what is the basis of your decision.

Case 1

LBCC Bike Shop needs to obtain a gear-cutting machine, which can be purchased for $75,000. LBCC Bike Shop estimates that repair, maintenance, insurance, and property tax expense will be $20,000 for the machine’s five-year life. At the end of the machine’s life, it will have no salvage value.

As an alternative, LBCC Bike Shop can lease the machine for five years for $18,000 per year. If the machine is leased, LBCC Bike Shop is required to pay only for routine maintenance on the machine, which is estimated to be $8,000 over the machine’s life. All other costs will be paid by the lessor. Should LBCC Bike Shop purchase or lease the machine.

Case 2

LBCC Bike Shop currently manufactures part A-14, one of the component parts used to assemble the company’s main product. Specialty Parts has offered to make part A-14 for $12.50 per unit.

LBCC Bike Shop per-unit cost to make part A-14 is $14.75, as follows:

      Direct materials                 $5.00

      Direct labor                            6.00

      Variable factory overhead     1.75

      Fixed factory overhead         2.00

None of LBCC Bike Shop’s fixed overhead costs will be eliminated if the part is purchased. However, the plant space currently used to manufacture the part can be leased to another company for $30,000 per year. Assuming that LBCC Bike Shop needs 100,000 parts per year, should the company continue to make part A-14 or buy it?

Case 3

LBCC Bike Shop sells oranges (from the trees in the parking lot) for $15.00 per case. The company has considered processing some of its oranges into orange juice. Each case of oranges will yield two dozen bottles of orange juice, which can be sold for $1.50 per bottle. The additional cost to process the oranges into orange juice is $0.75 per bottle. Determine whether LBCC Bike Shop should make the orange juice.

Case 4

LBCC Bike Shop uses oranges from the trees in the parking lot to produce orange juice. The cost to make each bottle is $2.05 and consists of the following:

            Direct materials                       $1.00

            Direct labor                              0.25

            Variable factory overhead      0.30

            Fixed factory overhead           0.50

A grocery store chain wants to purchase a generic brand orange juice from LBCC Bike Shop and is willing to pay $1.50 per bottle. The generic orange juice will be made using a different recipe, lowering the direct materials cost to $0.80 per bottle. LBCC Bike Shop can produce this special order using excess capacity; therefore, fixed costs will not increase. Determine whether LBCC Bike Shop should accept this special order.

Answer 1

Case 1 :

	Purchase	Lease
Cost of Purchase	$ 75,000
Lease Rent		$ 90,000
Repairs, maintenance etc	20,000	8,000
Total cost over the life of the asset	$ 95,000	$ 98,000

LBCC Bike Shop should purchase the machine.

Case 2 :

	Make A-14	Buy A -14
Cost of Purchase		$ 1,250,000
Relevant cost to make
Direct Materials	500,000
Direct Labor	600,000
Variable Factory Overhead	175,000
Opportunity Cost ( Lost Rent Revenue)	30,000
Total Relevant Costs	$ 1,305,000	$ 1,250,000

Financial advantage of buying the parts = $ 1,305,000 - $ 1,250,000 = $ 55,000.

Therefore, LBCC Bike Shop should buy the parts.

Case 3:

Incremental revenue from processing the oranges into orange juice = $ ( 2 x 12 x $ 1.50) - $ 15 = $ 21.

Incremental processing cost = 2 x 12 x $ 0.75 = $ 18.

Incremental contribution margin per case of oranges = $ 21 - $ 18 = $ 3

Therefore, LBCC Bike Shop should make the orange juice.

Case 4 :

Relevant cost for producing the generic orange juice per bottle = $ ( 0.80 + 0.25 + 0.30) = $ 1.35.

As the grocery store chain wants to pay $ 1.50 per bottle, contribution margin per bottle = $ 1.50 - $ 1.35 = $ 0.15

As operating income would increase by $ 0.15 per bottle of generic brand, LBCC Bike Shop should accept the special order.