Question

The Big Wheels Company currently purchases bicycle seats for its bikes for $30 each. The company has excess capacity and is considering the possibility of making the component. The Cost Accounting Department estimates that the following costs would be incurred to make each unit of the component:

Direct materials $ 8

Direct labor 10

Variable overhead     8

Fixed overhead (depreciation, rent, insurance)     7

Total manufacturing cost $33

Additionally, if Big Wheels decides to make the component, additional foremen, custodial personnel, and material handlers are required at a total cost of $120,000 per year. Assume the company uses 40,000 bike seats annually.

1.Should Big Wheels make or buy the bicycle seats it needs? Why?

2.At what volume of bike seats would the company change its decision?

Answer 1

$ Relevant cost of Manufacturing seats Particulars Amount Direct Materials 8.00 Direct Labour 10.00 Variable overheads 8.00 Total Variable Costs (p.u.) (a) 26.00 per unit No of seats required annually (b) 40000 units Total Variable Costs (axb) $ 10,40,000 Additional fixed Costs $ 1,20,000 A. Total Cost of manufacturing seats $ 11,60,000 $ Purchase price per unit (a) No of seats required (b) B. Total Cost of Purchasing seats 30.00 40000 units 12,00,000 $ As, cost of Manufacturing seats is lessor than Cost of purchasing seats, Big wheels Company shoulf Make bicycle seats. It would save ($1200000 - $1160000) = $ 40,000 per annum = Point of Indifference: Cost of Manufacturing $26 x units + $120000 ($30-$26) x units $4 x Units No of Units Cost of Purchasing $30x units $120000 $120000 $120000 / $4 30000 If company requires 30000 seats, it will be indifferent between the options (make or buy) If required seats > 30000 units If required seats < 30000 units MAKE BUY

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