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 $36 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				15,000 Units Per Year
Direct materials	$	12		$	180,000
Direct labor		12			180,000
Variable manufacturing overhead		4			60,000
Fixed manufacturing overhead, traceable		6	*		90,000
Fixed manufacturing overhead, allocated		9			135,000
Total cost	$	43		$	645,000

*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 15,000 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 $150,000 per year. Given this new assumption, what would be the financial advantage (disadvantage) of buying 15,000 carburetors from the outside supplier?

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

Answer 1

Answer

1.

Fixed Manufacturing Overhead, allocated is the Fixed Overhead which is allocated to this department, so it will still be there if we purchase this Unit,

So we will not consider this cost while making the decision.

And there will still be depreciation, so this 2/3 of Fixed Mfg. Overhead, Traceable will still be there so we will not consider this cost too.

	Per Unit		15,000 Units
	Differential Cost
	Make	Buy	Make	Buy
Cost of Purchasing	-	36	-	540,000.00
Cost of Making:
Material	12	-	180,000.00
Labor	12	-	180,000.00
Variable Overhead	4	-	60,000.00
Fixed Overhead, Traceable			30,000.00 ($90,000 * 1/3)
Total Cost	28	36	450,000.00	540,000.00

No, as there will be Disadvantage if we buy this Product as Cost of making is less than Purchasing.

Saving = $90,000 ($540,000 – 450,000)

2.

No, as there will be Disadvantage if we buy this Product as Cost of making is less than Purchasing.

Saving = $90,000

3.

	Per Unit		15,000 Units
	Differential Cost
	Make	Buy	Make	Buy
Cost of Purchasing	-	36	-	540,000.00
Cost of Making:
Material	12	-	180,000.00
Labor	12	-	180,000.00
Variable Overhead	4	-	60,000.00
Fixed Overhead, Traceable			30,000.00
Opportunity Cost			150,000.00
Total Cost	28	36	600,000.00	540,000.00

Yes, as there will be Advantage if we buy this Product as Cost of Purchasing is less than Making.

Disadvantage = $60,000 ($600,000 – 540,000)

4.

Yes, as there will be Advantage if we buy this Product as Cost of Purchasing is less than Making.

Disadvantage = $60,000 ($600,000 – 540,000)

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