The new toy Magic Dragon, is an organic plush toy packed in a special bag. The toy will be sold to wholesalers in boxes of 24 toys for $8 per box. Because of excess capacity, no additional fixed manufacturing overhead costs will be incurred to produce the toy. However, a $90,000 charge for fixed manufacturing overhead will be absorbed by the toy under the company’s absorption costing system. Using the estimated sales and production of 100,000 boxes of the Magic Dragon, the Accounting Department has developed the following cost per box:
Direct materials $3.60
Direct labor $2.00
Manufacturing overhead $1.40
Total cost $7.00
The costs above include costs for producing both the toy and the special bag that contains it. As an alternative to making the bags, Fun Toys has approached a supplier to discuss the possibility of purchasing the bags for the Magic Dragon. The purchase price of the bags from the supplier would be $1.35 per box of 24 bags. If Fun Toys Company accepts the purchase proposal, direct labor and variable manufacturing overhead costs per box of the Magic Dragon would be reduced by 10% and direct materials costs would be reduced by 25%.
Required:
1. Should Fun Toys Company make or buy the bags? Show calculations to support your answer.
2. What would be the maximum purchase price acceptable to Fun Toys Company? Explain.
