Question: Frank's bike company buys 60,000 brake pads each year at $6.50 per brake pad. The brake pad is a part that is used to manufacture its popular bikes. Frank's bike company has some excess space (currently being leased out) and idle machinery that could be used to manufacture the brake pads for the following per unit costs (based on 60,000 units).
DM $3.00
DL $1.00
VMOH $1.50
FMOH $2.00
Total $7.50
Fixed manufacturing overhead is allocated to all manufactured products and parts at the rate of 200% of direct labor cost. If Frank's bike company decides to manufacture the brake pads, they will have to cancel the current lease of excess space to a third party. Current annual revenue from the lease of excess space is $48,000.
Assuming Frank's bike company continues to need 60,000 bikes pads annually, should they manufacture the brake pads or continue to purchase from the third party vendor?
At what price per unit would Frank's bike company be indifferent as to whether they manufacture or purchase the brake pads?
Assume the while the company is considering whether to outsource the brake pads the current tenant of the excess space has decided to pay $8,000 penalty to cancel their lease. Because of a shortage of available commercial space you find that you can lease excess space for $60,000 annually. In addition, you have discovered the current molding equipment cannot be used to produce the brake pads, however, the equipment necessary to make the brake pads could be leased for $15,000 per year. Do you recommend that Frank's bike company manufacture or purchase the brake pads? What is the dollar difference in favor of your recommendation?