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	$	250
Fixed overhead		123
Total unit manufacturing costs				$	373
Unit nonmanufacturing costs
Variable		70
Fixed		143
Total unit nonmanufacturing costs					213
Total unit costs				$	586

The company has the capacity to produce 2,000 units per month and always operates at full capacity. The bicycles sell for $630 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 $150.

a-2. Should the proposal be accepted for a price (that is, payment to the contractor) of $150 per unit?

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 $8,300 each, while the costs of production would be $5,900 per unit variable manufacturing cost. Variable marketing costs would be $230 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.

b-1. Considering this opportunity to use the freed-up space, what is the maximum purchase price per unit that KCSB should be willing to pay the outside contractor to assemble regular bicycles?

b-2. Should the contractor’s proposal of $150 per unit be accepted?

Answer 1

Part a-1

In-house unit cost to compare to the supplier’s proposal = $203.50

Without contract:
	Per unit	Number of Bicycles	Total costs
Variable costs
Manufacturing	250	2000	500000
Non-manufacturing	70	2000	140000
Total variable costs	320		640000
Fixed costs
Manufacturing	123	2000	246000
Non-manufacturing	143	2000	286000
Total fixed costs	266		532000
Total cost	$586		$1172000

With contract:
For the bikes assembled by KCSB
	Per unit	Number of Bicycles	Total costs
Variable costs
For the bikes assembled by KCSB	320	1200	384000
For the bikes not assembled by KCSB	178	800	142400
Total variable costs			526400
Fixed costs
Manufacturing			196800
Non-manufacturing			286000
Total fixed costs			482800
Total cost			$1009200

Variable cost for bikes assembled by KCSB = (250*(1-40%))+(70*(1-60%)) =178

Fixed manufacturing costs = 246000*(1-20%) = 196800

In-house unit cost to compare to the supplier’s proposal = (1172000-1009200)/800 = $203.50

Part a-2

Yes, the proposal should be accepted for a price. The company would save $203.50 per unit while paying only $150 per unit to the outside contractor.

Part b-1

maximum purchase price = (472000+18400)/80 = $6130

	Status Quo	Accept Supplier’s Offer and Assemble 80 RacingBicycles	Difference
Revenue:
From regular bicycles	1260000	1260000	0
From racing bicycles		664000	664000
Total revenue	1260000	1924000	664000
Costs:
Variable costs
From regular bicycles	640000	526400	(113600)
Payment to supplier		114400	114400
For racing bicycles (manufacturing)		472000	472000
For racing bicycles (marketing)		18400	18400
Total variable cost	640000	1131200	491200
Fixed costs	532000	532000	0
Total cost	1172000	1663200	491200
Profit	88000	260800	172800

630*2000 = 1260000

80*8300= 664000

2000*320 = 640000

800*143 =114400

80*5900= 472000

80*230= 18400

Part b -2

Yes because the incremental revenue from the racing bicycles is greater than the incremental costs from using the supplier and assembling the racing bicycles.