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 119 Total unit manufacturing costs $ 359 Unit nonmanufacturing costs Variable 60 Fixed 139 Total unit nonmanufacturing costs 199 Total unit costs $ 558 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 15 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 $110. a-2. Should the proposal be accepted for a price (that is, payment to the contractor) of $110 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 $7,900 each, while the costs of production would be $5,500 per unit variable manufacturing cost. Variable marketing costs would be $190 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 $110. 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 $110 per unit be accepted? Yes No

Answer 1

Solution a-1:

Computation of In house unit cost relevant to assembly proposal - KCSB
Particulars	Amount
Reduction in variable manufacturing cost ($240*30%*800)	$57,600.00
Reduction in variable non manufacturing cost ($60*70%*800)	$33,600.00
Reduction in fixed manufacturing cost (2000*$119*15%)	$35,700.00
Total relevant cost of assembling 800 units	$126,900.00
Nos of units	800
In house cost per unit	$158.625

Solution a2:

As price offered by outside contractor is lesser than in house unit cost, therefore proposal should be accepted at a price of $110 per unit.

Solution b-1:

Computation of Income - Regular production of 2000 bicycle
Particulars	Amount
Sales (2000 * $600)	$1,200,000.00
Variable cost:
Variable manufacturing cost (2000*$240)	$480,000.00
Variable non manufacturing cost (2000*$60)	$120,000.00
Total Variable cost	$600,000.00
Contribution Margin	$600,000.00
Fixed Expenses:
Fixed Manufacturing cost (2000*$119)	$238,000.00
Fixed non manufacturing cost (2000*$139)	$278,000.00
Total fixed cost	$516,000.00
Net Income	$84,000.00

Solution b-2:

Computation of Income - Regular production of 1200 bicycle, 80 special racing bicycle
Particulars	Amount
Sales (2000 * $600 + 80*7900)	$1,832,000.00
Variable cost:
Assembly charges from outside contractor (800*$110)	$88,000.00
Variable manufacturing cost of regular bicycle (1200*$240 + 800*$168)	$422,400.00
Variable non manufacturing cost for regular bicycle (1200*$60 + 800*$18)	$86,400.00
Variable manufacturing cost of special racing bicycle (80*$5,500)	$440,000.00
Variable non manufacturing cost for special racing bicycle (80*$190)	$15,200.00
Total Variable cost	$1,052,000.00
Contribution Margin	$780,000.00
Fixed Expenses:
Fixed Manufacturing cost (2000*$119)	$238,000.00
Fixed non manufacturing cost (2000*$139)	$278,000.00
Total fixed cost	$516,000.00
Net Income	$264,000.00

Solution b-3:

As net income in accepting proposal from outside contractor is higher than regular production and sale of 2000 bicyle therefore, contractor's proposal of $110 per unit will be accepted.