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 $37 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				23,000 Units Per Year
Direct materials	$	16		$	368,000
Direct labor		9			207,000
Variable manufacturing overhead		4			92,000
Fixed manufacturing overhead, traceable		6	*		138,000
Fixed manufacturing overhead, allocated		9			207,000
Total cost	$	44		$	1,012,000

*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 23,000 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 $230,000 per year. Given this new assumption, what would be financial advantage (disadvantage) of buying 23,000 carburetors from the outside supplier?

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

Answer 1

Requirement 1

Statement of Cost Analysis(23000 Units)
	Make	Buy	Incremental (cost) or benefit
Purchase Price	$                       -	$      851,000.00	$      (851,000.00)
Direct Material	$      368,000.00	$                       -	$        368,000.00
Direct labor	$      207,000.00	$                       -	$        207,000.00
Variable Manufacturing Overheads	$        92,000.00	$                       -	$          92,000.00
Fixed Manufacturing Overheads, Traceable*	$        46,000.00*		$          46,000.00
Total Relevant Cost	$      713,000.00	$     851,000.00	$      (138,000.00)

Fixed Untraceable cost is irrelevant cost and would not become part for any decision making.

* Supervisor salary is avoidable fixed cost. It will be saved if carburetor is purchased from outside but depreciation will still be the same , so 2/3rd of fixed cost still occurs when Carburetor is purchased. Which means Depreciation is Irrelevant cost and hence excluded from relevant cost calculation. Alternatively Depreciation maybe added in both alternatives, the Relevant cost would increase by $92000 for each alternative.

The Supplier's Offer should be Rejected, since it has higher cost than Manufacturing. There is a Financial Disadvantage of $138,000.00 if Carburetor is purchased from outside.

Financial Disadvantage of Buying 22000 units from outside=$138,000

Requirement 2

The offer should not be accepted

Requirement 3

Statement of Cost Analysis
	Make	Buy	Incremental (cost) or benefit
Purchase Price	$                       -	$      851,000.00	$      (851,000.00)
Direct Material	$      368,000.00	$                       -	$        368,000.00
Direct labor	$      207,000.00	$                       -	$        207,000.00
Variable Manufacturing Overheads	$       92,000.00	$                       -	$          92,000.00
Fixed Manufacturing Overheads, Traceable	$        46,000.00		$          46,000.00
Benefits Achieved		$   (230,000.00)	$        230,000.00
Total Relevant Cost	$      713,000.00	$      621,000.00	$          92,000.00

The Offer should be Accepted Since Additional cost of Accepting offer is lower than additional benefits achived by accepting the offer. There is a Net Financial Advantage of Accepting the offer will be $92,000.00.

Requirement 4

The outside supplier’s offer can be accepted.