Sarasota Bicycles has been manufacturing its own wheels for its bikes. The company is currently operating at 100% capacity, and variable manufacturing overhead is charged to production at the rate of 30% of direct labor cost
The direct materials and direct labor cost per unit to make the wheels are $3.00 and $3.60 respectively. Normal production is 200,000 wheels per year.
A supplier offers to make the wheels at a price of $8 each. If the bicycle company accepts this offer, all variable manufacturing costs will be eliminated, but the $84,000 of fixed manufacturing overhead currently being charged to the wheels will have to be absorbed by other products.
Required:
a. Prepare an incremental analysis for the decision to make or buy the wheels.
b. Should Sarasota Bicycles buy the wheels from the outside supplier? Justify your answer.
Answer:
a. Make Buy
Direct materials (200,000 × $3.00) $600,000 -0-
Direct labor (200,000 × $3.60) 720,000 -0-
Variable manufacturing costs
($720,000 × 30%) 216,000 -0-
Purchase price (200,000 × $8) -0- 1,600,000
Total annual cost $1,536,000 $1,600,000
b. The wheels should continue to be manufactured by Sarasota Bicycles. The company's net income would decrease $64,000 by purchasing the wheels.
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