Wheels, Inc., currently manufactures its own custom rims for automobiles. Manage

Question

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 $15,000 units Variable production $20
cost
Direct materials         $10         $200,000
Direct labor               $30           100,000
Applied (and actual)                   300,000
factory overhead
Fixed production costs
Factory building and equipment lease 70,000
Factory insurance                                   50,000
Production supervisors salary             100,000
Total production costs                       $825,000
If production is outsourced, all variable production costs, factory building and equipment lease costs, and factory insurance costs will be eliminated. The production supervisors 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 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 the best? Explain.

Explanation / Answer

a) Differential Analysis for making rims internally or buying the rims (Amt. in $)

b) The Alternative 1 is best because in this alternative the total production costs is lower. The company should make the rims internally.

Particulars (Make internally) Alternative 1 (A) (Buy from outside) Alternative 2 (B) Differential Amount (A-B) Variable production costs: Cost to buy from outside 0 (10,000*80) = 800,000 (800,000) Direct Material 100,000 0 100,000 Direct Labor 300,000 0 300,000 Variable production costs 200,000 0 200,000 Fixed production costs: Factory building and equipment lease 70,000 0 70,000 Factory insurance costs 50,000 0 50,000 Production supervisors salary 100,000 100,000 0 Total Production costs 820,000 900,000 (80,000)

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