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	$	260
Fixed overhead		115
Total unit manufacturing costs				$	375
Unit nonmanufacturing costs
Variable		50
Fixed		135
Total unit nonmanufacturing costs					185
Total unit costs				$	560

The company has the capacity to produce 2,000 units per month and always operates at full capacity. The bicycles sell for $600 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 30 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 70 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.

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 $7,500 each, while the costs of production would be $5,100 per unit variable manufacturing cost. Variable marketing costs would be $150 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.

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.

Answer 1

a-1. Relevant in-house unit cost : $ 170.50

	$
Avoidable variable manufacturing cost ( $ 260 x 30 % x 800)	62,400
Avoidable fixed manufacturing cost ( $ 115 x 2,000 x 20%)	46,000
Avoidable variable nonmanufacturing cost ( $ 50 x 70% x 800)	28,000
Total cost savings	$ 136,400

Cost saving per unit = $ 136,400 / 800 = $ 170.50

a-2. Yes, the proposal should be accepted.

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

Contribution margin per unit = Unit Selling Price - Unit Variable Cost = $ 600 - $ ( 260 + 50) = $ 290

Profit ( loss) from 2,000 bicycles manufactured in-house = $ 290 x 2,000 - $ ( 115 + 135) x 2,000 = $ 80,000 per month.

b-2. When the company produces 1,200 units of regular bicycles and 80 racing bicycles:

Total contribution margin = 1,200 x $ 290 + 80 x ( 7,500 - 5,250 ) + 800 x ( 600 - 120) = $ 348,000 + $ 180,000 + $ 384,000 = $ 912,000.

Total net profit = $ 912,000 - $ 500,000 = $ 412,000 per month.