Question

King City Specialty Bikes (KCSB) produces high-end bicycles. The costs to manufacture and market the bicycles at the company's volume of 2,000 units per month are shown in the following table:

Unit manufacturing costs
Variable costs	$	230
Fixed overhead		112
Total unit manufacturing costs				$	342
Unit nonmanufacturing costs
Variable		40
Fixed		132
Total unit nonmanufacturing costs					172
Total unit costs				$	514

The company has the capacity to produce 2,000 units per month and always operates at full capacity. The bicycles sell for $550 per unit.

Required:

a. KCSB receives a proposal from an outside contractor who will assemble 800 of the 2,000 bicycles per month and ship them directly to KCSB’s customers as orders are received from KCSB’s sales force. KCSB would provide the materials for each bicycle, but the outside contractor would assemble, box, and ship the bicycles. The variable manufacturing costs would be reduced by 40 percent for the 800 bicycles assembled by the outside contractor. KCSB’s fixed nonmanufacturing costs would be unaffected, but its variable nonmanufacturing costs would be cut by 60 percent for these 800 units produced by the outside contractor. KCSB’s plant would operate at 60 percent of its normal level, and total fixed manufacturing costs would be cut by 20 percent.

a-1. Calculate the in-house unit cost that must be compared with the quotation received from the outside contractor. Assume the payment to the outside contractor is $120.

Unit Cost __________

a-2. Should the proposal be accepted for a price (that is, payment to the contractor) of $120 per unit?

	Yes
	No

b. Assume the same facts as in requirement (a) but assume that the idle facilities would be used to produce 80 specialty racing bicycles per month. These racing bicycles could be sold for $7,200 each, while the costs of production would be $4,800 per unit variable manufacturing cost. Variable marketing costs would be $120 per unit. Fixed nonmanufacturing and manufacturing costs would be unchanged whether the original 2,000 regular bicycles were manufactured or the mix of 1,200 regular bicycles plus 80 racing bicycles was produced. What is the total net profit/loss for the following.

b-1. When the company produces and sells 2,000 units of regular bicycles per month. Assume the payment to the outside contractor is $120.

Net Profit/Net Loss (Choose One)_______________ Amount?__________

b-2. When the company produces 1,200 units of regular bicycles and use the idle facilities to produce 80 specially racing bicycles per month.

Net Profit/Net Loss (Choose One)____________ Amount?_____________

b-3. Should the contractor’s proposal of $120 per unit be accepted? Yes/No

Answer 1

a-1 In-house unit cost that must be compared with the quotation received from the outside contractor is as follows:

Variable Manufacturing Cost 230*40%	92
Variable Non-Manufacturing Cost 40*60%	24
Fixed manufacturing Cost	56
Relevant Cost	$172

Note: Total Fixed Manufacturing cost = 112*2000 = $224,000

Reduction = 20% = $44,800

Per unit reduction = 44,800/800 = $56

Hence, unit cost = $172

a-2 Since payment to the outside contractor $120 is less than relevant cost of producing, the proposal be accepted for a price (that is, payment to the contractor) of $120 per unit

Yes

b-1 company produces and sells 2,000 units of regular bicycles per month:

Contribution Margin = (550-230-40)*2000 – 224,000 – 264,000 = $72,000

Net profit of $72,000

b-2 When the company produces 1,200 units of regular bicycles and use the idle facilities to produce 80 specially racing bicycles per month

Contribution Margin from regular bicycles = 280*1200 = 336,000

Contribution Margin from racing bicycles = (7200-4800-120)80 = 182,400

Fixed Costs 488,000

Net profit of $ 30,400

b-3 Yes, the proposal should be accepted.