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 $33 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	$	15		$	270,000
Direct labor		9			162,000
Variable manufacturing overhead		4			72,000
Fixed manufacturing overhead, traceable		6	*		108,000
Fixed manufacturing overhead, allocated		9			162,000
Total cost	$	43		$	774,000

*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 be accepted?

Answer 1

1)	Financial Disadvantage	54,000
		Make	Buy	Advantage/Disadvantage
	Direct Material	270,000
	Direct labour	162,000
	Variable manufacturing Overhead	72,000
	Fixed manufacture overhead (Only supervisor salary)	36,000
	Purchase Price		594,000
	Total Relevant cost	540,000	594,000	(54,000)
2)	No
3)	Financial Advantage	126,000
		Make	Buy	Advantage/Disadvantage
	Direct Material	270,000
	Direct labour	162,000
	Variable manufacturing Overhead	72,000
	Fixed manufacture overhead (Only supervisor salary)	36,000
	Purchase Price		594,000
	Segment margin of new product due to freed capacity	(180,000)
	Total Relevant cost	540,000	414,000	126,000
4)	Yes