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.

$ 359 Unit manufacturing costs Variable costs Fixed overhead Total unit manufacturing costs Unit nonmanufacturing costs Variable Fixed Total unit nonmanufacturing costs Total unit costs

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. What in-house unit cost should 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?

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 were 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 $110 per unit be accepted?

Please I need a detailed solution with calculation.

Answer 1

a-1) Inhouse cost that must be compared:

	amount($)
units	800
variable manufacturing cost	192000
fixed manufacturing cost	95200
total manufacturing cost	287200
non manufacturing cost
variable	48,000
fixed	1,11,200
total non manufacturing cost	1,59,200
total cost	4,46,400
cost per unit	558

a-2) Table showing cost when proposal is accepted

`	($)	($)
units	800
variable manufacturing cost	134400
fixed manufacturing cost	80920
total manufacturing cost		215320
non manufacturing cost
variable	14400
fixed	111200
total non manufacturing cost		125600
total cost		340920
cost per unit		426.15
+ price paid to contractor		110
total cost		536.15

Yes, proposal should be accepted at price $110 as it is less than cost of in house production.

b-1)

Profit from sale of 2000 regular cycles (accepting the proposal)

= $600 x 2000- ($558 x 1200+ $536.15 x 800)

= $1200000 – $1098520

= $101480

If company is using mix of 80 speciality cycles and 1200 regular cycles, profit must be atleast $101480.

Calculation of profit from sale of special cycles

sales price per unit	$7900
variable manufacturing cost per unit	$5500
variable marketing cost per unit	$190
total cost per unit	$5690
profit per unit	$2210
total profit for 80 units	$176800

Profit from 200o regular cycles = Profit from the mix

$101480 = $176800 + (600 x 1200 – 800y - 558 x 400)

$101480 = $176800 + 496800 - 800y

$101480 = $673600 – 800y

800y = $673600 - $101480

y = $572120/800

y = $715.15

It means total cost per unit for 800 units must be atmost $715.15.

Now, cost of production in case of contractor is $426.15 (without any charges paid to contractor)

Maximum price that can be paid to contractor = $715.15 - $426.15 = $289

b-2) As contractors price is $110 only, proposal must be accepted as it will increase the profit.