Wheels, Inc., currently manufactures its own custom rims for automobiles. Management is interested in outsourcing production of these rims to a reputable manufacturing company that can supply the rims for $80 per unit. Wheels, Inc., incurs the following annual production costs to produce 10,000 rims internally.

Per Unit

Total Annual Cost at 10,000 Units

Variable production costs

Direct materials

$ 20

$ 200,000

Direct labor

$ 10

100,000

Applied (and actual) factory overhead

$ 30

300,000

Fixed production costs

Factory building and equipment lease

70,000

Factory insurance

50,000

Production supervisor's salary

100,000

Total production costs

$ 820,000

If production is outsourced, all variable production costs, factory building and equipment lease costs, and factory insurance costs will be eliminated. The production supervisor's salary cost will remain regardless of the decision to outsource or to produce internally because the supervisor recently signed a long-term contract with Wheels, Inc.

Required:

a. Perform differential analysis using the format presented in Figure 7.2. Assume making the rims internally is Alternative 1, and buying the rims from an outside manufacturer is Alternative 2.

b. Which alternative is best? Explain.