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 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

Req 1.
Differential analysis
			Make	Buy	Effect on Income
Material cost		210000	0	210000
Labour cost		150000	0	150000
Variable Mfg oh		45000	0	45000
Fixed MFg oh-traceable	90000	60000	30000
Fixed Mfg oh-allocated	135000	135000	0
Cost of Purchase		0	525000	-525000
Total			630000	7,20,000	-90000
Net financial disadvantage of buying is ($ 90,000)
No, The offer shall not be accepted
Req 3.
Differential analysis
			Make	Buy	Effect on Income
Material cost		210000	0	210000
Labour cost		150000	0	150000
Variable Mfg oh		45000	0	45000
Fixed MFg oh-traceable	90000	60000	30000
Fixed Mfg oh-allocated	135000	135000	0
Cost of Purchase		0	525000	-525000
Opportunity cost-Contribution	150000	0	150000
Total			780000	7,20,000	60000
Net financial advantage of buying is $ 60,000.
Yes, the offer shall be accepted