King City Specialty Bikes (KCSB) produces high-end bicycles. The costs to manufacture and market the bicycles at the company's volume of 2,000 units per month are shown in the following table.

Unit manufacturing costs

Variable costs$260

Fixed overhead 126

Total unit manufacturing costs $386

Unit nonmanufacturing costs

Variable 50

Fixed 146

Total unit nonmanufacturing costs 196

Total unit costs $582

The company has the capacity to produce 2,000 units per month and always operates at full capacity. The bicycles sell for $620 per unit.

Required:

a. KCSB receives a proposal from an outside contractor who will assemble 800 of the 2,000 bicycles per month and ship them directly to KCSBs customers as orders are received from KCSBs sales force. KCSB would provide the materials for each bicycle, but the outside contractor would assemble, box, and ship the bicycles. The variable manufacturing costs would be reduced by 40 percent for the 800 bicycles assembled by the outside contractor. KCSBs fixed nonmanufacturing costs would be unaffected, but its variable nonmanufacturing costs would be cut by 60 percent for these 800 units produced by the outside contractor. KCSBs plant would operate at 60 percent of its normal level, and total fixed manufacturing costs would be cut by 20 percent.

a-1. What in-house unit cost should be compared with the quotation received from the outside contractor? Assume the payment to the outside contractor is $150.

a-2. Should the proposal be accepted for a price (that is, payment to the contractor) of $150 per unit?

b. Assume the same facts as in requirement (a) but assume that the idle facilities would be used to produce 80 specialty racing bicycles per month. These racing bicycles could be sold for $8,600 each, while the costs of production would be $6,200 per unit variable manufacturing cost. Variable marketing costs would be $260 per unit. Fixed nonmanufacturing and manufacturing costs would be unchanged whether the original 2,000 regular bicycles were manufactured or the mix of 1,200 regular bicycles plus 80 racing bicycles was produced.

b-1. Considering this opportunity to use the freed-up space, what is the maximum purchase price per unit that KCSB should be willing to pay the outside contractor to assemble regular bicycles?

b-2. Should the contractors proposal of $150 per unit be accepted?