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 $40 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 18,000 Units Per Year Direct materials $ 18 $ 324,000 Direct labor 9 162,000 Variable manufacturing overhead 2 36,000 Fixed manufacturing overhead, traceable 9 * 162,000 Fixed manufacturing overhead, allocated 12 216,000 Total cost $ 50 $ 900,000 *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 18,000 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 $180,000 per year. Given this new assumption, what would be the financial advantage (disadvantage) of buying 18,000 carburetors from the outside supplier? 4. Given the new assumption in requirement 3, should the outside supplier’s offer

Answer 1

Ans:

1) Differential analysis
Number of Units	18,000	18,000
	Make	Buy
Direct material	324000
Direct labor	162000
Variable manufacturing overhead	36000
Fixed manufacturing overhead   (162000/3)	54000
Purchase Cost   (18000*40)		720000
Total differential cost	576000	720000
	Make	Buy
Total Differential Cost (Per Unit)	32	40
Financial (disadvantage) = 576000-720000=-144000
2) No, should not accept the offer
3) Differential analysis
	Make	Buy
Direct material	324000
Direct labor	162000
Variable manufacturing overhead	36000
Fixed manufacturing overhead   (162000/3)	54000
Opportunity Cost	180,000
Purchase Cost   (18000*40)		720000
Total Differential Cost	756,000	720000
Financial (disadvantage) = 756000-720000=36000
4) yes, should accept the offer

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