Bombay makes bicycle seats that they sell for $33 to retailers. Annually they pr
ID: 2505096 • Letter: B
Question
Bombay makes bicycle seats that they sell for $33 to retailers. Annually they produce and sell 20,000 units. Their costs are as follows. Direct Materials: $6 Direct Labor: $5 Variable Overhead: 3 Fixed Overhead: 4 they can buy the same quality seats from an outside supplier for $20 and save 60% of their fixed overhead. What should they do and how much will it affect operating income? At what price from their supplier would they be indifferent to make or buy? What are the qualitative factors in this decision?
Explanation / Answer
Total Fixed Cost = Fixed Overhead
= 20000*4
= $80000
Total Variable Cost = Direct materials p.u+ Direct labor p.u. + Variable OH p.u.
= 6 + 5 + 3
= $14 p.u.
Total cost if the company produces = 20000*14 + 80000
= $360000
Total cost if the company buys the seats from the outside supplier = 20000*20 + 60%of80000
= 400000 + 48000
= 448000
Net operating will decrease by $88000 since, Total cost increases by $88000 [448000-360000]
They should not buy it from the outside supplier and instead manufacture it themselves.
Let the indifferent price be
Total Fixed Cost = Fixed Overhead
= 20000*4
= $80000
Total Variable Cost = Direct materials p.u+ Direct labor p.u. + Variable OH p.u.
= 6 + 5 + 3
= $14 p.u.
Total cost if the company produces = 20000*14 + 80000
= $360000
Total cost if the company buys the seats from the outside supplier = 20000*20 + 60%of80000
= 400000 + 48000
= 448000
Net operating will decrease by $88000 since, Total cost increases by $88000 [448000-360000]
They should not buy it from the outside supplier and instead manufacture it themselves.
Let the indifferent price be