Question

Troy Engines, Ltd., manufactures a variety of engines for use in heavy equipment. The company has always produced all of the necessary parts for its engines, including all of the carburetors. An outside supplier has offered to sell one type of carburetor to Troy Engines, Ltd., for a cost of $35 per unit. To evaluate this offer, Troy Engines, Ltd., has gathered the following information relating to its own cost of producing the carburetor internally:

	Per Unit				16,000 Units per Year
Direct materials	$	16		$	256,000
Direct labor		12			192,000
Variable manufacturing overhead		3			48,000
Fixed manufacturing overhead, traceable		3	*		48,000
Fixed manufacturing overhead, allocated		6			96,000
Total cost	$	40		$	640,000

*One-third supervisory salaries; two-thirds depreciation of special equipment (no resale value).

Required:

1. Assuming the company has no alternative use for the facilities that are now being used to produce the carburetors, what would be the financial advantage (disadvantage) of buying 16,000 carburetors from the outside supplier?

2. Should the outside supplier’s offer be accepted?

3. Suppose that if the carburetors were purchased, Troy Engines, Ltd., could use the freed capacity to launch a new product. The segment margin of the new product would be $160,000 per year. Given this new assumption, what would be the financial advantage (disadvantage) of buying 16,000 carburetors from the outside supplier?

4. Given the new assumption in requirement 3, should the outside supplier’s offer be accepted?

Answer 1

						per unit
						Differential cost		16,000	units
						make	buy	make	Buy
Cost of purchasing							35		560000
Direct materials						16		256000
direct labor						12		192000
variable manufacturing overhead						3		48000
fixed manufacturing overhead ,traceable						1		16000
fixed manufacturing overhead,common						0	0
total costs						32	35	512000	560000
Difference in favor of continuing to make the carburetors						3		48000
						Make	Buy
1a)	total relevant cost (16,000 units)					512000	560000
	financial disadvantage					48,000	answer
1b)	Reject
2a)							make	Buy
	cost of purchasing (part1)							560000
	cost of making (part 1)						512000
	opportunity cost- segment margin forgone						160,000
	total cost						672000	560000
	difference in favour of purchasing from outside supplier							112000
						Make	Buy
	total relevant cost (16,000 units)					672000	560000
	financial advantage					112,000	answer
2b)	Accept