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 $40 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	$	18		$	324,000
Direct labor		9			162,000
Variable manufacturing overhead		2			36,000
Fixed manufacturing overhead, traceable		9	*		162,000
Fixed manufacturing overhead, allocated		12			216,000
Total cost	$	50		$	900,000

*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 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

Solution 1:

Differential Analysis- Troy Engines Ltd - Making Carburetor or Buying Carburetor
Particulars	Making Carburetor	Buying Carburetor	Financial advantage (Disadvantage) of buying Carburetor
Costs:
Purchase Price (18000*$40)	$0.00	$7,20,000.00	-$7,20,000.00
Direct material	$3,24,000.00	$0.00	$3,24,000.00
Direct Labor	$1,62,000.00	$0.00	$1,62,000.00
Variable overhead	$36,000.00	$0.00	$36,000.00
Avoidable Fixed Overhead ($162,000*1/3)	$54,000.00	$0.00	$54,000.00
Total Cost	$5,76,000.00	$7,20,000.00	-$1,44,000.00

Solution 2:

No, outside supplier’s offer should not be accepted as there is financial disadvantage of $144,000.

Solution 3:

Differential Analysis - Making Carburetor or Buying Carburetor
Particulars	Making Carburetor	Buying Carburetor	Financial advantage (Disadvantage) of buying Carburetor
Costs:
Purchase Price (18000*$40)	$0.00	$7,20,000.00	-$7,20,000.00
Direct material	$3,24,000.00	$0.00	$3,24,000.00
Direct Labor	$1,62,000.00	$0.00	$1,62,000.00
Variable overhead	$36,000.00	$0.00	$36,000.00
Avoidable Fixed Overhead ($162,000*1/3)	$54,000.00	$0.00	$54,000.00
Loss of opportunity of new product margin	$1,80,000.00	$0.00	$1,80,000.00
Total Cost	$7,56,000.00	$7,20,000.00	$36,000.00

Solution 4:

Yes, outside supplier’s offer should be accepted as there is financial advantage of $36,000.