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	$	13		$	208,000
Direct labor		13			208,000
Variable manufacturing overhead		2			32,000
Fixed manufacturing overhead, traceable		9	*		144,000
Fixed manufacturing overhead, allocated		12			192,000
Total cost	$	49		$	784,000

*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

Solution 1:

Computation of Financial Advantage (Disadvantage)
	Make	Buy	Financial advantage (disadvantage)
Direct materials	$208,000.00	$0.00	$208,000.00
Direct labor	$208,000.00	$0.00	$208,000.00
Variable manufacturing overhead	$32,000.00	$0.00	$32,000.00
Fixed manufacturing overhead, traceable	$144,000.00	$96,000.00	$48,000.00
Fixed manufacturing overhead, allocated	$192,000.00	$192,000.00	$0.00
Purchase price (16000 x $35)	$0.00	$560,000.00	-$560,000.00
Total costs	$784,000.00	$848,000.00	-$64,000.00

Solution 2:

No, Outside supplier’s offer should not be accepted as there is financial disadvantage of $64000.

Solution 3:

Computation of Financial Advantage (Disadvantage)
	Make	Buy	Financial advantage (disadvantage)
Direct materials	$208,000.00	$0.00	$208,000.00
Direct labor	$208,000.00	$0.00	$208,000.00
Variable manufacturing overhead	$32,000.00	$0.00	$32,000.00
Fixed manufacturing overhead, traceable	$144,000.00	$96,000.00	$48,000.00
Fixed manufacturing overhead, allocated	$192,000.00	$192,000.00	$0.00
Opportunity cost (Segemnt Margin of New Product	$160,000.00	$0.00	$160,000.00
Purchase price (16000 x $35)	$0.00	$560,000.00	-$560,000.00
Total costs	$944,000.00	$848,000.00	$96,000.00

Solution 4:

Yes, Outside supplier’s offer should be accepted as there is financial advantage of $96000.