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 $30 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				19,000 Units Per Year
Direct materials	$	12		$	228,000
Direct labor		10			190,000
Variable manufacturing overhead		3			57,000
Fixed manufacturing overhead, traceable		3	*		57,000
Fixed manufacturing overhead, allocated		6			114,000
Total cost	$	34		$	646,000

*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 19,000 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 $190,000 per year. Given this new assumption, what would be the financial advantage (disadvantage) of buying 19,000 carburetors from the outside supplier?

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

Answer 1

Answer to 1st Question:
a) Cost of producing carburetors:
Particulars	Amount (per unit)
Direct materials	12
Direct labor	10
Variable manufacturing overheads	3
Fixed manufacturing overheads, traceable (Refer Note 1)	1
Fixed manufacturing Overheads, allocated (Refer Note 2)	0
Cost of producing carburetors	26

Notes:

1. Only 1/3rd of Fixed manufacturing overheads, traceable is relevant for decision making since only cost of supervisor is avoidable.

2. Fixed manufacturing overheads, allocated are not relevant for decision making and are sunk cost since they will be continued to be incurred even if carburetors are bought from outside supplier.

Answer to 2nd Question:

No, outside supplier's offer should not be accepted since the cost of producing carburetors ($26) is lower than the purchase price from outside supplier ($30).

Answer to 3rd Question:

Calculation of cost of producing carburetor
Particulars	Amount ($)
Cost of producing carburetor as calculated above in 1st answer	26
Add: Opportunity Cost ($190,000/19,000 units)	10
Total Cost of producing carburetor	36

Answer to 4th Question:

Yes, outside supplier's offer should now be accepted since the cost of producing carburetors ($36) is higher than the purchase price from outside supplier ($30).