Question

Zachary Bike Company makes the frames used to build its bicycles. During 2018, Zachary made 21,000 frames; the costs incurred follow:

Unit-level materials costs (21,000 units × $51)	$	1,071,000
Unit-level labor costs (21,000 units × $57)		1,197,000
Unit-level overhead costs (21,000 × $10)		210,000
Depreciation on manufacturing equipment		91,000
Bike frame production supervisor’s salary		64,400
Inventory holding costs		340,000
Allocated portion of facility-level costs		600,000
Total costs	$	3,573,400

Zachary has an opportunity to purchase frames for $119 each.

Additional Information

The manufacturing equipment, which originally cost $590,000, has a book value of $430,000, a remaining useful life of six years, and a zero salvage value. If the equipment is not used to produce bicycle frames, it can be leased for $79,000 per year.

Zachary has the opportunity to purchase for $950,000 new manufacturing equipment that will have an expected useful life of six years and a salvage value of $85,400. This equipment will increase productivity substantially, reducing unit-level labor costs by 50 percent. Assume that Zachary will continue to produce and sell 21,000 frames per year in the future.

If Zachary outsources the frames, the company can eliminate 90 percent of the inventory holding costs.

Required

A. Determine the avoidable cost per unit of making the bike frames, assuming that Zachary is considering the alternatives of making the product using the existing equipment or outsourcing the product to the independent contractor. Based on the quantitative data, should Zachary outsource the bike frames?

Avoidable Cost Per Unit: ?

B. Assuming that Zachary is considering whether to replace the old equipment with the new equipment, determine the avoidable cost per unit to produce the bike frames using the new equipment and the avoidable cost per unit to produce the bike frames using the old equipment. Calculate the increase or decrease in the company's profit if the company uses new equipment.

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Answer 1