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				17,000 Units Per Year
Direct materials	$	17		$	289,000
Direct labor		8			136,000
Variable manufacturing overhead		4			68,000
Fixed manufacturing overhead, traceable		6	*		102,000
Fixed manufacturing overhead, allocated		9			153,000
Total cost	$	44		$	748,000

*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 17,000 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 $170,000 per year. Given this new assumption, what would be the financial advantage (disadvantage) of buying 17,000 carburetors from the outside supplier?

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

Answer 1

Calculations of Relevant production cost per unit of carburettor-

Direct material. 17
Direct Labour. 8
Variable manufacturing overhead. 4
Fixed manufacturing overhead. 2
(Traceable) ( note 1)
Fixed manufacturing overhead. nil
(Allocated) (note-2)

Total Relevant cost 31

Note1- As special equipment is already purchased, depreciation cost is sunk cost
Note2- Allocated cost is always sunk cost

Ans-1-: As company has no alternative use for the facilities that are now being used to produce the carburetors there is no financial benefits if we purchase the carburettor. So the we will face financial disadvantage as our relevant manufacturing cost is 31 where as our purchase cost will be 35

Ans-2-; we should not accept the proposal as we will suffer loss of $4 per unit if we accept the proposal.

Ans-3-: the financial advantage we will get $170000 per year by manufacturing another product using the vacant capacity.

Ans -4-:

Loss we will suffer- (17000×4) =68000
Gain from additional product= 170000

Net gain (170000-68000)= $102000

So we should accept the offer.