Talboe Company makes wheels that it uses in the production of children's wagons. Talboe's costs to produce 200,000 wheels annually are as follows:$\begin{array}{lrr}
\text {Direct materials } &£40,000\
\text {Direct labour. } &60,00\
\text {Variable manufacturing overhead } &30,000\
\text {Fixed manufacturing overhead } &\underline{70,000}\
\text {Total } &\underline{£200,000}\
\end{array}$

An outside supplier has offered to sell Talboe similar wheels for £0.80 per wheel. If the wheels are purchased from the outside supplier, £25,000 of annual fixed manufacturing overhead would be avoided and the facilities now being used to make the wheels would be rented to anther company for £55,000 per year.
- What is the highest price that Talboe could pay the outside supplier for each wheel and still be economically indifferent between making or buying the wheels?

A)£0.95
B)£1.15
C)£1.00
D)£1.05

Question

Talboe Company makes wheels that it uses in the production of children's wagons. Talboe's costs to produce 200,000 wheels annually are as follows:$\begin{array}{lrr}
  \text {Direct materials  } &£40,000\
 \text {Direct labour.  } &60,00\
 \text {Variable manufacturing overhead  } &30,000\
 \text {Fixed manufacturing overhead  } &\underline{70,000}\
 \text {Total  } &\underline{£200,000}\
\end{array}$

An outside supplier has offered to sell Talboe similar wheels for £0.80 per wheel. If the wheels are purchased from the outside supplier, £25,000 of annual fixed manufacturing overhead would be avoided and the facilities now being used to make the wheels would be rented to anther company for £55,000 per year.
- What is the highest price that Talboe could pay the outside supplier for each wheel and still be economically indifferent between making or buying the wheels?

A)£0.95
B)£1.15
C)£1.00
D)£1.05

Quizplus · Accepted Answer

To determine the highest price Talboe could pay the outside supplier per wheel and still be economically indifferent between making or buying the wheels, we need to calculate the total cost of making the wheels and then divide by the number of wheels to find the cost per wheel. The total cost of making the wheels includes direct materials, direct labor, variable manufacturing overhead, and the fixed manufacturing overhead that cannot be avoided if the wheels are not made in-house. If the wheels are purchased from the outside supplier, Talboe can avoid £25,000 of the fixed manufacturing overhead and earn £55,000 by renting out the facilities. Therefore, the savings and additional income should be subtracted from the total cost of making the wheels in-house to find the equivalent cost of buying.The total cost of making the wheels is £200,000. If Talboe buys the wheels, it can avoid £25,000 of fixed costs and gain £55,000 from renting out the facilities, totaling £80,000 (£25,000 + £55,000) in savings and additional income. Subtracting this from the total in-house production cost gives us £120,000 (£200,000 - £80,000) as the equivalent cost for buying the wheels. Dividing this by the number of wheels (200,000) gives us £0.60 per wheel as the cost of making them in-house, considering the savings and additional income. To find the highest price Talboe could pay the outside supplier and still be indifferent, we need to add back the savings and income per wheel that would be lost if the wheels were not made in-house. This is the £80,000 spread over 200,000 wheels, which equals £0.40 per wheel. Adding this to the £0.60 in-house cost per wheel gives us £1.00 as the break-even price per wheel. However, since Talboe would want to be economically indifferent, they would be willing to pay slightly more than this break-even cost, making £1.05 the highest price they could pay and still be indifferent.

Talboe Company Makes Wheels That It Uses in the Production