Make or buy with opportunity costs. Lorenzo Manufacturing, Inc., produces bicycles.

The costs of manufacturing and marketing bicycles at the company's normal volume of 3,000 units per month follow:

Unless otherwise stated, assume that the situations described in the questions are not connected; treat each independently. Unless otherwise stated, assume a regular selling price of $ 1 ,000 per unit and a volume of 3,000 bicycles per month.

a. Lorenzo Manufacturing receives a proposal from an outside contractor who will make and ship 1,000 units per month directly to Lorenzo Manufacturing's customers as L orenzo Manufacturing's sales force receives orders. The proposal would not affect Lorenzo Manufacturing's fixed nonmanufacturing costs, but its variable nonmanufacturing costs would decline by 20 percent for these 1,000 units produced by the contractor. Lorenzo Manufacturing's plant would operate at two-thirds of its normal level. Total fixed manufacturing costs would decline by 30 percent.
What in-house unit cost should the firm use to compare with the quotation received from the supplier? Should the firm accept the proposal for a price (that is, payment to the contractor) of $600 per unit?

b. Assume the same facts as in part a., except that the firm will use idle facilities to produce 800 three-wheel bicycles per month. It can sell these three-wheel bicycles for $1,200 each, while the costs of production would be $700 per unit variable manufacturing cost. Variable nonmanufacturing costs would be $100 per unit.
Fixed nonmanufacturing and manufacturing costs will not change whether the firm manufactures the original 3,000 regular bicycles or the mix of 2,000 regular bicycles plus 800 three-wheel bicycles. What is the maximum purchase price per unit that Lorenzo Manufacturing should be willing to pay the outside contractor?
Should it accept the proposal for a price of $600 per unit?

Transcribed Image Text:

LORENZO MANUFACTURING Costs per Unit Unit Manufacturing Costs Variable Materials. $100 Variable Labor... 150 Variable Overhead. 50 Fixed Overhead.... 200 Total Unit Manufacturing Costs. $500