Question

Ellington Company manufactures a line of motorbikes and dirt bikes under the trade name CrossCountry. The company has been in business for almost 20 years and has maintained a profitable share of the recreational vehicle market due to its reputation for high-quality products. In addition, Ellington’s engineering department has kept the company in the forefront by incorporating the latest technology in the CrossCountry bikes. Most subassembly work for the bikes is subcontracted to reliable vendors. However, the final assembly and inspection of all products is performed at Ellington’s plant.

Ellington recently developed a new braking system for the CrossCountry Model-500 dirt bike. Because of the company’s current availability of production capacity, Jim Walsh, production manager, recommended that the first lot of the new braking system be manufactured in-house rather than by subcontractors. This 190-unit production run has now been completed. The cumulative average labor hours per unit for the braking system was 190 hours. Ellington’s experience with similar products indicates that a learning curve of 80% is applicable and that the learning factor can be expected to extend only through the fourth production run (190 per batch) for a total of 760 units.

 

Ellington’s direct labor cost is $30 per direct labor hour. Its management must decide whether to continue producing the braking system in its own plant or to subcontract this work. Joyce Lane, Ellington’s purchasing agent, has received a proposal from MACQ, a company specializing in component assembly. MACQ has done work in the past for Ellington and has proved to be a high-quality and reliable vendor. The terms of MACQ’s proposal are negotiable, and before beginning discussions with them, Joyce has decided to conduct some relevant financial analysis.

Required:

1. Ellington Company has an immediate requirement for a total of 1,300 units of the braking system. Determine the company’s future direct labor costs to produce the required braking system units if it manufactures the units in-house.

2. A consultant has advised Joyce that the learning rate for this application might be closer to 75%. What is the effect on projected costs of using a 75% learning rate as opposed to an 80% learning rate? (Do not round intermediate calculations.)