Question

2)

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				22,000 Units Per Year
Direct materials	$	15		$	330,000
Direct labor		8			176,000
Variable manufacturing overhead		3			66,000
Fixed manufacturing overhead, traceable		3	*		66,000
Fixed manufacturing overhead, allocated		6			132,000
Total cost	$	35		$	770,000

*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 22,000 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 $220,000 per year. Given this new assumption, what would be financial advantage (disadvantage) of buying 22,000 carburetors from the outside supplier?

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

1.

The Regal Cycle Company manufactures three types of bicycles—a dirt bike, a mountain bike, and a racing bike. Data on sales and expenses for the past quarter follow:

	Total			Dirt Bikes			Mountain Bikes			Racing Bikes
Sales	$	927,000		$	261,000		$	408,000		$	258,000
Variable manufacturing and selling expenses		470,000			118,000			202,000			150,000
Contribution margin		457,000			143,000			206,000			108,000
Fixed expenses:
Advertising, traceable		70,100			8,700			40,800			20,600
Depreciation of special equipment		43,100			20,700			7,300			15,100
Salaries of product-line managers		115,700			40,100			38,700			36,900
Allocated common fixed expenses*		185,400			52,200			81,600			51,600
Total fixed expenses		414,300			121,700			168,400			124,200
Net operating income (loss)	$	42,700		$	21,300		$	37,600		$	(16,200)

*Allocated on the basis of sales dollars.

Management is concerned about the continued losses shown by the racing bikes and wants a recommendation as to whether or not the line should be discontinued. The special equipment used to produce racing bikes has no resale value and does not wear out.

Required:

1. What is the financial advantage (disadvantage) per quarter of discontinuing the Racing Bikes?

2. Should the production and sale of racing bikes be discontinued?

3. Prepare a properly formatted segmented income statement that would be more useful to management in assessing the long-run profitability of the various product lines.

Answer 1

1	Relevant Cost of 22000 Units
		Make	Buy
	Direct Material	15
	Direct Labor	8
	Variable Man Ovh	3
	Traceable Ovh	1
	(Only Salary can be avoided, equipment is sunk cost and can no be avoided. 3*1/3
	Purchase Cost		35
	Total Cost Per unit	27	35
	Units	22000	22000
	Total Cost	594000	770000
2	Supplier offer should not be accepted as cost of purchaing component is higher

3.

3
		Make	Buy
	Cost of Making	594000		From Part-1
	Purchasing Cost		770000	From Part-1
	Opportunity Cost-New Product Margin	220000
	Total Relevant Cost	814000	770000
4	Since Purchasing Cost is less than make cost, offer at $35 should be accepted

Regal Cycle Company:

1		Existing Total	Total If Raing Bike Discontinued	Diff
	Sales	927000	669000	-258000
	Variable Manu & Selling	470000	320000	-150000
	Contribution	457000	349000	-108000
	Advertising Traceable	70100	49500	-20600
	Dep of Special Equip (Sunk Cost)	43100	43100	0	Can not be avoided if Racing Line Discontinued
	Salaries of Prod Line	115700	78800	-36900
	Allocated Common Fixed Exp	185400	185400	0	Can not be avoided if Racing Line Discontinued
	Total Fixed Exp	414300	356800	-57500
	Net Operating Income/(Loss)	42700	-7800	-50500
2	Since Regal will be loosing $50500 Operating income, its not advisable to discontinue Racing Bike

3.

	Total	Dire Bike	Mountain Bike	Racing Bike
Sales	927000	261000	408000	258000
Variable Manu & Selling	470000	118000	202000	150000
Contribution A	457000	143000	206000	108000
Traceable Fixed Exp:
Advertising Traceable	70100	8700	40800	20600
Dep of Special Equip (Sunk Cost)	43100	20700	7300	15100
Salaries of Prod Line	115700	40100	38700	36900
Total Traceable Fixed Exp B	228900	69500	86800	72600
Product Line Contribution Margin A-B=C	228100	73500	119200	35400
Allocated Common Fixed Exp	185400
Net Operating Income/(Loss)	42700