Riggs Company purchases sails and produces sailboats. It currently produces 1,300 sailboats per year, operating at normal capacity, which is about 80% of full capacity. Riggs purchases sails at $258 each, but the company is considering using the excess capacity to manufacture the sails instead. The manufacturing cost per sail would be $93 for direct materials, $83 for direct labor, and $90 for overhead. The $90 overhead is based on $78,000 of annual fixed overhead that is allocated using normal capacity. The president of Riggs has come to you for advice. "It would cost me $266 to make the sails," she says, "but only $258 to buy them. Should I continue buying them, or have I missed something?"

Answer: The president of Riggs is missing something. The cost of making the sails is $176 and therefore costs $82 lesser to make a sail rather than buy one.

Explanation:

Given the following;

Direct material per sail = $93

Direct labor per sail = $83

Kindly Note the following:

Sail is manufactured while operating at 80% of full capacity

Overhead of $90 is based on annual fixed overhead while operating at normal capacity (that is 80% of full capacity). The implication his, to utilize the remaining 20%, no fixed overhead will have to be incurred.

All that is needed to make the sail will be the variable cost;

Direct material = $90

Direct labor = $83

Total variable cost = $ (93 + 83) = $176

The president of Riggs has incorrectly included $90 overhead into the manufacturing cost of the sails.

Therefore, total manufacturing cost of the sails is $176 and not $266.

Therefore it costs $82 lesser to make a sail.

The president of Riggs has missed something.

She should make the Sail instead of buying because its cheaper to manufacture than purchasing it outside.

Explanation:

Cost of Manufacturing the Sails:

Direct materials $93

Direct Labor $83

Total $173

The president of Riggs has included the $90 overhead based on $78,000 of annual fixed overhead that is allocated using normal capacity in the cost of manufacturing the sail which is incorrect.

Riggs Company is operating at 80 % of full capacity, hence utelizing the 20% excess capacity would not expand its fixed costs.

Thus said the current fixed cost are irrelevent for this decison and would be incurred whether or not Riggs Company utilizes the excess capacity

Conclusion:

The cost of making the sail is $173 which is lower than the cost of buying them at $ 258.

I would advise The president of Riggs to make the sail by utilizing the excess capacity since its cheaper than purchasing it outside.