Question

Riggs Company purchases sails and produces sailboats. It currently produces 1,250 sailboats per year, operating at normal capacity, which is about 80% of full capacity. Riggs purchases sails at $256 each, but the company is considering using the excess capacity to manufacture the sails instead. The manufacturing cost per sail would be $90.54 for direct materials, $89.54 for direct labor, and $90 for overhead. The $90 overhead includes $78,500 of annual fixed overhead that is allocated using normal capacity. The president of Riggs has come to you for advice. “It would cost me $270.08 to make the sails,” she says, “but only $256 to buy them. Should I continue buying them, or have I missed something?”

Prepare a per unit analysis of the differential costs.

If Riggs suddenly finds an opportunity to rent out the unused capacity of its factory for $78,000 per year, would your answer to part (a) change?

Answer 1

1		Make sails	Buy sails	Net income
				Increase/decrease
	Direct material	90.54		90.54
	Direct labor	89.54		89.54
	Variable overheads	27.20		27.20
	Purchase price		256	-256
	Total units cost	207.28	256	-48.72
	Total overheads	90
	Fixed overheads	62.80	(78500/1250)
	Variable overheads per unit	27.20
2	Should make as total unit cost is less in making
3	Total decrease in unit cost	48.72
	Number of units	1250
	Total cost decrease	60900
	Rent per year	78000
	Net income will increase by	17100
		Yes