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	$	240
Fixed overhead		120
Total unit manufacturing costs				$	360
Unit nonmanufacturing costs
Variable		60
Fixed		140
Total unit nonmanufacturing costs					200
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 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. What in-house unit cost should be compared with the quotation received from the outside contractor? Assume the payment to the outside contractor is $140.

a-2. Should the proposal be accepted for a price (that is, payment to the contractor) of $140 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 $8,000 each, while the costs of production would be $5,600 per unit variable manufacturing cost. Variable marketing costs would be $200 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 $140.

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.

b-3. Should the contractor’s proposal of $140 per unit be accepted?

	Yes

Answer 1

When Producing 2000 units per month inhouse, then

Variable manufacturing cost = 240 per unit

Variable non manufacturing cost = 60 per unit

Total Manufacturing fixed cost = 126*2000= 252,000

Total Non manufacturing fixed cost =146*2000=292,000

Profiut earned = (600-560)*2000=80,000

Now, when outsourced to contractor for 800 units, the cost will be as follows

Variable manufacturing cost = 240*1200+ (240-40%)*800=4032,00

Variable non manufcaturing cost =60*1200+ (60-60%)*800=91,200

Fixed Manufacturing cost =252000-20%=201600

Fixed non manufcaturing cost = 292,000

Contractor cost=140*800=112,000

Therefore, Revised Cost after outsourcing = 403200+91200+201600+292,000+112000=1100000

Therefore per unit cost =1100000/2000=550 per unit

Saving in cost= 560-550= 19 per unit

Therefore Increase in profits = (600*2000-1100,000)-80,000=20,000

Therefore, proposal must be accepted.

Now, if the idle capacity is utilized for producing 80 racing bicycles, then

Fixed manufacturing cost will come upto =252,000

Fixed non manufcaturing cost will come upto =292000

That means increased fixed cost will be $ 50,400 (252,000-201600)

And Variable cost for 80 racing cycles will be = 5600*80+2000*80=464000

Sales revenue of 80 racing cycles = 8000*80=640,000

Therfore, profits from 80 racing cycle would be =640,000-464000-50400=125600

Therefore, the proposal of contratcor must be accepted and idle capacity must be utilized for producing 80 racing cycles.