Outsourcing decision affected by equipment replacement
Jenkins Bike Company (JBC) makes the frames used to build its bicycles. During 2011, JBC
made 20,000 frames; the costs incurred follow.
Unit-level materials costs (20,000 units × $45) | $ 900,000 |
Unit-level labor costs (20,000 units × $51) | 1,020,000 |
Unit-level overhead costs (20,000 × $9) | 180,000 |
Depreciation on manufacturing equipment | 90,000 |
Bike frame production supervisor’s salary | 70,000 |
Inventory holding costs | 290,000 |
Allocated portion of facility-level costs | 500,000 |
Total costs | $3,050,000 |
JBC has an opportunity to purchase frames for $110 each.
Additional Information
1. The manufacturing equipment, which originally cost $450,000, has a book value of $360,000, a remaining useful life of four years, and a zero salvage value. If the equipment is not used to produce bicycle frames, it can be leased for $70,000 per year.
2. JBC has the opportunity to purchase for $910,000 new manufacturing equipment that will have an expected useful life of four years and a salvage value of $70,000. This equipment will increase productivity substantially, reducing unit-level labor costs by 60 percent. Assume that JBC will continue to produce and sell 20,000 frames per year in the future.
3. If JBC outsources the frames, the company can eliminate 80 percent of the inventory holding costs.
Required
a.Determine the avoidable cost per unit of making the bike frames, assuming that JBC is considering the alternatives between making the product using the existing equipment and outsourcing the product to the independent contractor. Based on the quantitative data, should JBC outsource the bike frames? Support your answer with appropriate computations.
b. Assuming that JBC is considering whether to replace the old equipment with the new equipment, determine the avoidable cost per unit to produce the bike frames using the new equipment and the avoidable cost per unit to produce the bike frames using the old equipment. Calculate the impact on profitability if the bike frames were made using the old equipment versus the new equipment.
c. Assuming that JBC is considering to either purchase the new equipment or outsource the bike frame, calculate the impact on profitability between the two alternatives.
d. Discuss the qualitative factors that JBC should consider before making a decision to outsource the bike frame. How can JBC minimize the risk of establishing a relationship with an unreliable supplier?
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