Question

# Sarasota Bicycles has been manufacturing its own wheels for its bikes. The company is currently operating...

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.

a)

 Make (200,000 wheels) Buy(200,000 wheels) Direct Material = 200,000 x \$3 \$600,000 ------------------------------- Direct Labour = 200,000 x \$3.6 \$720,000 ------------------------------- Variable Manufacturing Overhead = \$720,000 x 30% \$216,000 ------------------------------- Buying Price = 200,000 x \$8 ------------------------------- \$1,600,000 Total annual cost for 200,000 wheels \$1,536,000 \$1,600,000

b) Sarasota Bicycles should continue to manufacture wheels because if accepting the proposal of outsider supplier, Sarasota Bicycles net income will decrease by \$64,000 (\$1,600,000 - \$1,536,000). So, continue to manufacturing wheels and do not accept the proposal of ouside supplier.

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