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				15,000 Units per Year
Direct materials	$	14		$	210,000
Direct labor		10			150,000
Variable manufacturing overhead		3			45,000
Fixed manufacturing overhead, traceable		6	*		90,000
Fixed manufacturing overhead, allocated		9			135,000
Total cost	$	42		$	630,000

*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

Solution :

(1) Financial Advantage ( Disadvantage) when company has no alternative use :

Particulars	Make	Buy	Advantage ( Disadvantage) (Buy)
Direct Material Cost for 15,000 Units	$ 210,000		$ 210,000
Direct Labor Cost for 15,000 Units	$ 150,000		$ 150,000
Variable Manufacturing Overhead	$ 45,000		$ 45,000
Avoidable Fixed Manufacturing Overhead	$ 30,000		$ 30,000
Purchasing Cost		15,000 * 35 = $ 525,000	($ 525,000)
Total	$ 435,000	$ 525,000	($ 90,000)

* Only Supervispry Salaries are relevant as these cost are avoidable cost= 90,000 * 1/3 = $ 30,000

There is a financial disadantage of $ 90,000 if carburetors are purchased from outside.

(2) Since there is financial disadvantage of $ 90,000 therefore outside suplier offer should not be accepted.

(3) If Carburetor are purchased from outside and free capacity is used for new product :

Particulars	Make	Buy	Advantage (Disadvantage) (Buy)
Direct Material Cost for 15,000 Units	$ 210,000		$ 210,000
Direct Labor Cost for 15,000 Units	$ 150,000		$ 150,000
Variable Manufacturing Overhead	$ 45,000		$ 45,000
Avoidable Fixed Manufacturing Overhead	$ 30,000		$ 30,000
Opportunity Cost from New Product	$ 150,000		$ 150,000
Purchasing Cost		15,000 * 35 = $ 525,000	($ 525,000)
Total	$ 585,000	$ 525,000	$ 60,000

Financial Advantage in this case would be $ 60,000 if carburetaor are purchased from outside supplier and free up capacity is used to launch a new product.

(4) Yes, Since there is financial advantage of $ 60,000. Outside supplier offer should be accepted.