Question

Sheffield Rides makes bicycles. It has always purchased its bicycle tires from the Balyo Tires at $11 each but is currently considering making the tires in its own factory. The estimated costs per unit of making the tires are as follows:

Direct materials		$4
Direct labor		$4
Variable manufacturing overhead		$2

The company’s fixed expenses would increase by $29,820 per year if managers decided to make the tire.

(a1) Calculate total relevant cost to make or buy if the company needs 5,460 tires a year.

	Make	Buy
Total relevant cost	$	$

(a2) Ignoring qualitative factors, if the company needs 5,460 tires a year, should it continue to purchase them from Balyo or begin to produce them internally?

The company                                                           should continueshould not continue to purchase the tires.

Answer 1

Answer (a1)

Calculation of Relevant cost of manufacturing and relevant cost of purchasing

Make	Amount (in $)	Buy	Amount (in $)
Direct Material (5,460 tires X $ 4.00 per tire)	21,840	Purchase Cost	60,060
Direct Labor (5,460 tires X $ 4.00 per tire)	21,840	(5,460 tires X $ 11.00 per tire)
Variable Manufacturing Overhead (5,460 tires X $ 2.00 per tire)	10,920
Increase in Fixed Expenses	29,820
Total Relevant Cost of manufacturing in house	84,420	Total Relevant Cost of purchase	60,060

The relevant cost of manufacturing 5,460 tires is $ 84,420 and the relevant cost of purchase of 5,460 tires is $ 60,060.

Answer (a2) If the qualitative factors are ignored, the company should continue purchase of tires from Balyo tires as the purchase cost of 5,460 tires (i.e. $ 60,060) is than its cost of manufacture (i.e. $ 84,420).