Question

Exercise 12-3 Make or Buy Decision [LO12-3] 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 $ 17 $ 340,000 Direct labor 10 200,000 Variable manufacturing overhead 2 40,000 Fixed manufacturing overhead, traceable 9 * 180,000 Fixed manufacturing overhead, allocated 12 240,000 Total cost $ 50 $ 1,000,000 *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?

Answer 1

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?

	MAKE	BUY
Direct Material	$ 340,000		[20000 units X $17]
Direct Labour	$ 200,000		[20000 units X $10]
Variable Mfr O/H	$   40,000		[20000 units X $2]
Fixed Mfr O/H, Traceable (1/3 is avoidable)	$   60,000		[20000 units X $9 X 1/3]
Purchase Price from outside supplier ($36 * 20000)		$ 720,000	[20000 units X $36]
Total Relevant Costs	$ 640,000	$ 720,000

Financial advantage (disadvantage) of outside supplier offer

($80,000)

[$720000 - $640000]

2. Should the outside supplier’s offer be accepted?

Offer Should not 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?

	MAKE	BUY
Direct Material	$ 340,000		[20000 units X $17]
Direct Labour	$ 200,000		[20000 units X $10]
Variable Mfr O/H	$   40,000		[20000 units X $2]
Fixed Mfr O/H, Traceable (1/3 is avoidable)	$   60,000		[20000 units X $9 X 1/3]
Purchase Price from outside supplier ($36 * 20000)		$ 720,000	[20000 units X $36]
Alternate segment margin		$(200,000)
Total Relevant Costs	$ 640,000	$ 520,000

Financial advantage (disadvantage) of outside supplier offer

$120,000

[$640000 - $520000]

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

Offer should be accepted