5. Sarasota Bicycles has been manufacturing its own wheels for its bikes. The company is currently operating at 100% capacity, and variable manufacturing overhead is charged to production at the rate of 30% of direct labor cost. The direct materials and direct labor cost per unit to make the wheels are $3.00 and $3.60 respectively. Normal production is 200,000 wheels per year. A supplier offers to make the wheels at a price of $8 each. If the bicycle company accepts this offer, all variable manufacturing costs will be eliminated, but the $84,000 of fixed manufacturing overhead currently being charged to the wheels will have to be absorbed by other products. Required: a. Prepare an incremental analysis for the decision to make or buy the wheels. b. Should Sarasota Bicycles buy the wheels from the outside supplier

a. Incremental Analysis for making the wheels at Sarasota Bicycles is as follows:

                                       Make              Buy                   Differential

                                  Alternative 1   Alternative 2            Cost

Relevant cost per unit      $7.68              $8.00             $0.32 ($8.00 - $7.68)

Total cost                 $1,536,000    $1,600,000    $64,000 (200,000 x $0.32)

b. Sarasota should not buy the wheels from the outside supplier.  It should continue to make them as it saves $64,000 per year from making the wheels.

Data and Calculations:

Direct materials cost per unit = $3.00

Direct labor cost per unit =        $3.60

Variable manufacturing overhead = $1.08 ($3.60 x 30%)

Total variable cost per unit =  $7.68

Number of wheels per year = 200,000

Outside Supplier's Price = $8 per unit

Thus, Sarasota Bicycles gains $64,000 by making the wheels instead of buying from the outside supplier.

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It is better to make the wheels

Explanation:

Sarasota Bicycles

Incremental Analysis

                                            Make             Buy

Direct materials                 $3.00

Direct labor                        $3.60

Variable OH (3.06*30%)    1.08

Total                                   7.68                  8

Normal production  200,000                    200,000

Total Costs                    1536000            1600,000

Fixed Overheads         84,000                 84,000      

Total Costs                   1620,000             1684,000  

As fixed costs are irrelevant costs that would not change whether the company makes or buys wheels and the cost to make the wheels $7.08 is less than the cost to buy $ 8.0. It is better to make the wheels . Buying the wheels from the outside supplier  is costly.