Gibson Bike Company makes the frames used to build its bicycles. During 2018, Gi
ID: 2413932 • Letter: G
Question
Gibson Bike Company makes the frames used to build its bicycles. During 2018, Gibson made 22,000 frames; the costs incurred follow:
Gibson has an opportunity to purchase frames for $125 each.
Additional Information
The manufacturing equipment, which originally cost $510,000, has a book value of $460,000, 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.
Gibson has the opportunity to purchase for $970,000 new manufacturing equipment that will have an expected useful life of four years and a salvage value of $65,200. This equipment will increase productivity substantially, reducing unit-level labor costs by 50 percent. Assume that Gibson will continue to produce and sell 22,000 frames per year in the future.
If Gibson outsources the frames, the company can eliminate 80 percent of the inventory holding costs.
Required
Determine the avoidable cost per unit of making the bike frames, assuming that Gibson 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 Gibson outsource the bike frames?
Assuming that Gibson 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 increase or decrease in the company's profit if the company uses new equipment.
Assuming that Gibson is considering whether to either purchase the new equipment or outsource the bike frame, calculate.
Unit-level materials costs (22,000 units × $53) $ 1,166,000 Unit-level labor costs (22,000 units × $55) 1,210,000 Unit-level overhead costs (22,000 × $12) 264,000 Depreciation on manufacturing equipment 99,000 Bike frame production supervisor’s salary 62,800 Inventory holding costs 340,000 Allocated portion of facility-level costs 540,000 Total costs $ 3,681,800Explanation / Answer
Total cost in case of buying
Particulars
Amount ($)
Amount ($)
Frames (22000 x 125)
2750000
Add: inventory holding costs (340000-272000)
68000
Depreciation (460000/4)
115000
Allocated portion of facility level costs
540000
723000
Total costs of buying
3473000
Less: Lease rent to be received
70000
Cost of buying 22000 frames
3403000
Number of frames
22000
Cost of buying per unit (3403000 / 22000)
154.6818
Note: It has been assumed that the bike frame production’s supervisor salary is variable cost and not fixed.
Total cost of manufacturing currently
Total cost of manufacturing
3681800
Number of frames
22000
Cost of manufacturing per unit (3681800 / 22000)
167.3545
Avoidable cost per unit in case of buying (167.3545-154.6818)
12.67273
As can be seen that the decision to buy the bike frames would help the company to reduce the cost of each frame by $12.67 thus, the company should buy the frames for $125 each and leased out the equipment for $70000 per year.
Thus, using the new machine
Total cost using old machine
3681800
Less:
Depreciation under old machine as provided
99000
Unit level labour costs
1210000
1309000
2372800
Add:
Depreciation on the new equipment
226200
Unit level labour cost per unit {22000 x (55 x 50%)}
605000
831200
Total cost of manufacturing bike frames
3204000
Number of bike frames
22000
Cost per unit (3204000/22000)
145.6364
Thus cost per unit:
Under existing equipment
If purchased from outside
Under new equipment
Cost of each unit of bike frame
167.3545
154.6818
145.6364
Hence, it is clear from the above that the company should acquire the new equipment as this is the best option for the company.
Workings:
Depreciation in case new equipment purchased
New equipment costs
970000
Salvage value
65200
Useful life of the asset
4
Annual depreciation (970000 - 65200) /4
226200
Total cost in case of buying
Particulars
Amount ($)
Amount ($)
Frames (22000 x 125)
2750000
Add: inventory holding costs (340000-272000)
68000
Depreciation (460000/4)
115000
Allocated portion of facility level costs
540000
723000
Total costs of buying
3473000
Less: Lease rent to be received
70000
Cost of buying 22000 frames
3403000
Number of frames
22000
Cost of buying per unit (3403000 / 22000)
154.6818
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