E14.7 Riggs Company purchases sails and produces sailboats. It currently produces 1,200 sailboats per year, operating at normal capacity, which is about 80% of full capacity. Riggs purchases sails at $250 each, but the company is considering using the excess capacity to manufacture the sails instead. The manufacturing cost per sail would be $100 for direct materials, $80 for direct labor, and $90 for overhead. The $90 overhead is based on $78,000 of annual fixed overhead that is allocated using normal capacity.

The president of Riggs has come to you for advice. It would cost me $270 to make the sails, she says, but only $250 to buy them. Should I continue buying them, or have I missed something?

Instructions

1. Prepare a per unit analysis of the differential costs. Briefly explain whether Riggs should make or buy the sails.

Increase

Make Sails Buy Sails (Decrease)

Direct materials

Direct labor

Variable overhead

Purchase price

Total unit cost

Net Income

2. If Riggs suddenly finds an opportunity to rent out the unused capacity of its factory for $77,000 per year, would your answer to part (a) change? Briefly explain.

Per Make Buy Increase

(Based on 1,200 units) Unit Sails Sails (Decrease)

Manufacturing cost

Purchase price

Opportunity cost

Total annual cost

2. Identify three qualitative factors that should be considered by Riggs in this make-or-buy decision.