Mike is considering setting up a business manufacturing custom bicycle frames. He is a keen cyclist and has many contacts with managers of local bicycle shops who could send business his way. He has found a unit to rent and worked out some preliminary estimates of costs he would have to incur.

The firm will manufacture frames made from either aluminium alloy or carbon fibre. Mikes analysis tells you that because aluminium is cheaper and easier to work with each aluminium frame would have a direct materials cost of 100 and direct labour cost of 40. Carbon fibre frames are expected to have a direct materials cost of 200 and direct labour cost of 60.

Irrespective of which type of frame is produced, the business will also incur the following annual fixed costs:

Rent 12,500

Machinery maintenance 2,000

Spare parts 500

Heat, light, electricity, and water 4,000

Quality control 2,500

The annual machine hours are budgeted to be 1,000 hours. Mike estimates that a single carbon fibre frame will require 20 hours to be manufactured, whereas a single aluminium frame can be manufactured in just 8 hours. The selling prices of the two frames are calculated by adding a 40% mark-up to the total cost of each frame.

Required:

A. Calculate the unit total cost and the unit selling price for the two frames Mike is considering. Show your workings. (12 marks)

B. Mike would like to find out how many units of each product he would have to make and sell in order to break even and asks you to calculate the break-even volumes of sales. Show your workings. (6 marks)

C. He also tells you that he would like to earn 15,000 per year from his business. How many units of each product would he have to make and sell in order to earn that amount? Show your workings. (4 marks)

D. As Mikes firm is still relatively unknown, he expects he will only be able to sell 55 frames in his first year in business. Which type of bicycle frame should he sell? (2 marks)

E. Traditional absorption costing is obsolete in the context of modern manufacturing. Discuss.