Question

In: Accounting

Troy Engines, Ltd., manufactures a variety of engines for use in heavy equipment. The company has...

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 $36 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 20,000 Units
Per Year
Direct materials $ 13 $ 260,000
Direct labor 11 220,000
Variable manufacturing overhead 4 80,000
Fixed manufacturing overhead, traceable 6 * 120,000
Fixed manufacturing overhead, allocated 9 180,000
Total cost $ 43 $ 860,000

*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 20,000 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 $200,000 per year. Given this new assumption, what would be the financial advantage (disadvantage) of buying 20,000 carburetors from the outside supplier?

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

Solutions

Expert Solution

per unit
Differential cost 20,000 units
make buy make Buy
Cost of purchasing 36 720000
Direct materials 13 260000
direct labor 11 220000
variable manufacturing overhead 4 80000
fixed manufacturing overhead ,traceable 2 40000
fixed manufacturing overhead,common 0 0
total costs 30 36 600000 720000
Difference in favor of continuing to make the carburetors 6 120000
Make Buy
1a) total relevant cost (20,000 units) 600000 720000
financial disadvantage 120,000 answer
1b) Reject
2a) make Buy
cost of purchasing (part1) 720000
cost of making (part 1) 600000
opportunity cost- segment margin forgone 200,000
total cost 800000 720000
difference in favour of purchasing from outside supplier 80000
Make Buy
total relevant cost (20,000 units) 800000 720000
financial advantage 80,000
2b) Accept

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