Sturdy Bike Company makes the frames used to build its bicycles. During 2018, Sturdy made 20,000 frames; the costs incurred follow:
Unit-level materials costs (20,000 units × $35.00)..........$ 700,000
Unit-level labor costs (20,000 units × $42.50).................850,000
Unit-level overhead costs (20,000 × $10.00) ..................200,000
Depreciation on manufacturing equipment.....................120,000
Bike frame production supervisor's salary.......................70,000
Inventory holding costs...........................................290,000
Allocated portion of facility-level costs.........................500,000
Total costs.......................................................$2,730,000
Sturdy has an opportunity to purchase frames for $92.50 each.
Additional Information
1. The manufacturing equipment, which originally cost $550,000, has a book value of $450,000, a remaining useful life of four years, and a zero salvage value. If the equipment is not used to produce bicycle frames, it can be leased for $70,000 per year.
2. Sturdy has the opportunity to purchase for $910,000 new manufacturing equipment that will have an expected useful life of four years and a salvage value of $70,000. This equipment will increase productivity substantially, reducing unit-level labor costs by 60 percent. Assume that Sturdy will continue to produce and sell 20,000 frames per year in the future.
3. If Sturdy outsources the frames, the company can eliminate 80 percent of the inventory holding costs.
Required
a. Determine the avoidable cost per unit of making the bike frames, assuming that Sturdy is considering the alternatives of making the product using the existing equipment or outsourcing the product to the independent contractor. Based on the quantitative data, should Sturdy outsource the bike frames? Support your answer with appropriate computations.
b. Assuming that Sturdy is considering whether to replace the old equipment with the new equipment, determine the avoidable cost per unit to produce the bike frames using the new equipment and the avoidable cost per unit to produce the bike frames using the old equipment. Calculate the impact on profitability if the bike frames were made using the old equipment versus the new equipment.
c. Assuming that Sturdy is considering whether to either purchase the new equipment or outsource the bike frame, calculate the impact on profitability between the two alternatives.
d. Discuss the qualitative factors that Sturdy should consider before making a decision to outsource the bike frame. How can Sturdy minimize the risk of establishing a relationship with an unreliable supplier?