Question

PART A

The Regal Cycle Company manufactures three types of bicycles—a dirt bike, a mountain bike, and a racing bike. Data on sales and expenses for the past quarter follow:

	Total			Dirt Bikes			Mountain Bikes			Racing Bikes
Sales	$	921,000		$	265,000		$	401,000		$	255,000
Variable manufacturing and selling expenses		486,000			119,000			210,000			157,000
Contribution margin		435,000			146,000			191,000			98,000
Fixed expenses:
Advertising, traceable		70,100			8,500			40,600			21,000
Depreciation of special equipment		43,600			20,200			7,900			15,500
Salaries of product-line managers		116,100			40,700			38,700			36,700
Allocated common fixed expenses*		184,200			53,000			80,200			51,000
Total fixed expenses		414,000			122,400			167,400			124,200
Net operating income (loss)	$	21,000		$	23,600		$	23,600		$	(26,200)

*Allocated on the basis of sales dollars.

Management is concerned about the continued losses shown by the racing bikes and wants a recommendation as to whether or not the line should be discontinued. The special equipment used to produce racing bikes has no resale value and does not wear out.

Required:

1. What is the financial advantage (disadvantage) per quarter of discontinuing the Racing Bikes?

2. Should the production and sale of racing bikes be discontinued?

3. Prepare a properly formatted segmented income statement that would be more useful to management in assessing the long-run profitability of the various product lines.

PART B

Troy Engines, Ltd., manufactures a variety of engines for use in heavy equipment. The company has always produced all of the necessary parts for its engines, including all of the carburetors. An outside supplier has offered to sell one type of carburetor to Troy Engines, Ltd., for a cost of $30 per unit. To evaluate this offer, Troy Engines, Ltd., has gathered the following information relating to its own cost of producing the carburetor internally:

	Per Unit				12,000 Units Per Year
Direct materials	$	12		$	144,000
Direct labor		8			96,000
Variable manufacturing overhead		2			24,000
Fixed manufacturing overhead, traceable		9	*		108,000
Fixed manufacturing overhead, allocated		12			144,000
Total cost	$	43		$	516,000

*One-third supervisory salaries; two-thirds depreciation of special equipment (no resale value).

Required:

1. Assuming the company has no alternative use for the facilities that are now being used to produce the carburetors, what would be the financial advantage (disadvantage) of buying 12,000 carburetors from the outside supplier?

2. Should the outside supplier’s offer be accepted?

3. Suppose that if the carburetors were purchased, Troy Engines, Ltd., could use the freed capacity to launch a new product. The segment margin of the new product would be $120,000 per year. Given this new assumption, what would be financial advantage (disadvantage) of buying 12,000 carburetors from the outside supplier?

4. Given the new assumption in requirement 3, should the outside supplier’s offer be accepted?

Answer 1

1
	Current Total	Total If Racing Bikes Are Dropped	Difference: Net Operating Income
Sales	921000	666000	-255000
Variable manufacturing and selling expenses	486000	329000	157000
Contribution margin (loss)	435000	337000	-98000
Fixed expenses:
Advertising, traceable	70100	49100	21000
Depreciation on special equipment	43600	43600	0
Salaries of product manager	116100	79400	36700
Common allocated costs	184200	184200	0
Total fixed expenses	414000	356300	57700
Net operating income (loss)	21000	-19300	-40300
Financial (disadvantage) $(40300)
2
No, production and sale of racing bikes should not be discontinued
3
	Total	Dirt Bikes	Mountain Bikes	Racing Bikes
Sales	921000	265000	401000	255000
Variable manufacturing and selling expenses	486000	119000	210000	157000
Contribution margin (loss)	435000	146000	191000	98000
Traceable fixed expenses:
Advertising, traceable	70100	8500	40600	21000
Depreciation on special equipment	43600	20200	7900	15500
Salaries of product manager	116100	40700	38700	36700
Total traceable fixed expenses	229800	69400	87200	73200
Product line segment margin	205200	76600	103800	24800
Common fixed expenses	184200
Net operating income (loss)	21000

Part-B
1
	Per unit		Total 12000 units
	Make	Buy	Make	Buy
Direct materials	12		144000
Direct labor	8		96000
Variable manufacturing overhead	2		24000
Fixed manufacturing overhead traceable	3		36000
Purchase cost		30		360000
Total			300000	360000
Difference = 300000-360000 = $(60000)
Financial (disadvantage) $(60000)
2
No, the outside supplier’s offer should not be accepted
3
	Make	Buy
Total cost	300000	360000
Opportunity cost	120000
Total relevant cost	420000	360000
Difference = 420000-360000 = $60000
Financial advantage = $60000
4
Yes, accept the offer