TWR Inc. produces bicycles. Current production is 10,000 units per year. Current
ID: 2446263 • Letter: T
Question
TWR Inc. produces bicycles. Current production is 10,000 units per year. Currently, a critical component of the bicycles, their chains, is produced in-house. The following information is available about the cost of making 10,000 chains per year:
Cost per unit Total for 10,000 units
Direct Materials 4.00 40,000
Direct Manufacturing Labor 2.00 20,000
Variable Manufacturing OH 1.50 15,000
Inspection, Setup, materials handling 0.20 2,000
Machine Rent 0.30 3,000
Allocated fixed costs of production facilities 3.00 30,000
Total manufacturing costs 11.00 110,000
TWR has received an offer from an outside vendor to supply any number of chains that it requires at $8.20 per chain. The following additional information is available:
Inspection, setup and materials handling costs vary with the number of batches in which the chains are produced. The cost per batch does not depend on the number of units in each batch. TWR will produce the 10,000 chains in 10 batches of 1,000 chains each.
TWR rents the machine used to make the chains. If TWR buys all the chains it needs from the outside vendor, it can cancel the machine rental with no penalty and will no longer need to pay the machine rent.
Required
Assume that if TWR purchases the chains from the outside vendor, the current facilities where the chains are produced will remain idle. On the basis of financial considerations alone, should TWR accept the offer from the outside vendor at the anticipated sales volume of 10,000 bicycles (each bike needs one chain)?
For this question, assume that if the chains are sourced externally, the facilities where the chains are currently made can be used to upgrade the bikes by adding mud flaps and reflectors. This will increase the selling price of the bike by $20 (with no effect on sales volume). The variable cost per bike for the upgrade is $18 and they will need to incur additional tooling costs of $16,000. What should TWR do?
The sales manager at TWR, Jerry, is concerned that the estimate of 10,000 bikes sold may be too high and says that he believes only 6,200 bikes may be sold for the year. The production manager, Wade, immediately agrees with Jerry and says that he believes that he can cut back production to produce 6,200 bikes in 8 batches freeing up some work space. This can be used to add the mud flaps and the reflectors referred to in 2 above regardless of whether the chains are made or bought. What should Jerry do?
Explanation / Answer
a) If purchased from outside cost = 10,000@ 8.2 = $82,000
If make then
Variable cost ( 4+2+1.5) 10,000 = $75,000
inspection cost 2,000
Machine rent 3,000
total cost of maoking $80,000
thus Jerry should make its own chain as it will save him $2000
b) If the company makes then the cost is $80,000
Under buy alternative
cost of production 10,000 @8.2 $82,000
Addittional cost of tools $16,000
Addittional margin($20 - $18) 2,000
total cost $78,000
Hence jerry should buy chains form external sources and upgrade its bikes
c) Cost of manufacturing is
Varaible cost ( 6200 *7.5) $46,500
Batch cost 2000/10*8 1,600
Machine rent 3,000
Total cost $51,100
Cost of buying 6200@8.20 = $50,480
hence jerry should buy the chains
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