Question

The Talbot Corporation makes wheels that it uses in the production of bicycles. Talbot's costs to produce 110,000 wheels annually are: Direct materials $22,000 Direct labor $33,000 Variable manufacturing overhead $16,500 Fixed manufacturing overhead $59,000 An outside supplier has offered to sell Talbot similar wheels for $0.80 per wheel. If the wheels are purchased from the outside supplier, $14,000 of annual fixed overhead could be avoided and the facilities now being used could be rented to another company for $37,700 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?

Answer 1

Indifferent Purchase price per wheel = $123,200/110,000 = $1.12

Step-by-step explanation:

Provided that:

Number of wheels produced: 110,000

Cost for these wheels in case of manufacturing

Direct Material = $22,000

Direct Labor = $33,000

Variable Manufacturing Overhead = $16,500

Fixed Manufacturing Overhead = $59,000

Total Cost = $130,500

Rate of outside supplier = $0.80

Then total cost in case of purchase = Purchase cost + Unavoidable fixed cost - Rent Revenue

= $0.80
`*` 110,000 + ($59,000 - $14,000) - $37,700

= $88,000 + $45,000 - $37,700

= $95,300

since net effect of buying the wheels is a gain of $130,500 - $95,300 = $35,200

Thus the wheels shall be bought and not manufactured.

The price at which the buying and manufacturing option will be indifferent shall be:

Purchase Price + Unavoidable Fixed Cost - Rent Revenue = Manufacturing cost

Purchase Price + $45,000 - $37,700 = $130,500

Purchase Price = $123,200

Purchase price per wheel = $123,200/110,000 = $1.12