The Talbot Corporation makes wheels that it uses in the production of bicycles.

Question

The Talbot Corporation makes wheels that it uses in the production of bicycles. Talbot's costs to produce 100,000 wheels annually are: Direct materials $30,000 Direct labor $50,000 Variable manufacturing overhead $20,000 Fixed manufacturing overhead $70,000 An outside supplier has offered to sell Talbot similar wheels for $1.25 per wheel. If the wheels are purchased from the outside supplier, $15,000 of annual fixed overhead could be avoided and the facilities now being used could be rented to another company for $45,000 per year. Direct labor is a variable cost. At what purchase price for the wheels would Talbot be indifferent between making or buying the wheels? A-$1.70 per wheel B-$1.60 per wheel C-$1.55 per wheel D-$1.15 per wheel

Explanation / Answer

The company would be indifferent in making and buying when both the costs are euqal.

Assume that when the purchase price is Z, the company is indifferent between making or buying.

Therefore,

Direct materials + Direct labor + Variable overhead + Fixed overhead = (100,000 x Z) + Unavoidable fixed overhead - Rent

Or,

$30,000 + $50,000 + $20,000 + $70,000 = (100,000 x Z) + ($70,000 - $15,000) - $45,000

Or,

$160,000 = 100,000 x Z

Or,

Z = $160,000/100,000 = $1.60

Thus,

When the purchase price is $1.60 per wheel, the company would be indifferent between making or buying.

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