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 $32 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 17,000 Units Per Year Direct materials $ 14 $ 238,000 Direct labor 8 136,000 Variable manufacturing overhead 3 51,000 Fixed manufacturing overhead, traceable 3 * 51,000 Fixed manufacturing overhead, allocated 6 102,000 Total cost $ 34 $ 578,000 *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 17,000 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 $170,000 per year. Given this new assumption, what would be financial advantage (disadvantage) of buying 17,000 carburetors from the outside supplier? 4. Given the new assumption in requirement 3, should the outside supplier’s offer be accepted?

Answer 1

Answer 1

Statement of Cost Analysis(15000 Units)
	Make	Buy	Incremental (cost) or benefit
Purchase Price	$                       -	$      544,000.00	$      (544,000.00)
Direct Material	$      238,000.00	$                       -	$        238,000.00
Direct labor	$      136,000.00	$                       -	$        136,000.00
Variable Manufacturing Overheads	$        51,000.00	$                       -	$          51,000.00
Fixed Manufacturing Overheads, Traceable*	$        51,000.00	$        34,000.00	$          17,000.00
Fixed Manufacturing Overheads, Allocated	$      102,000.00	$      102,000.00	$                          -
	$      578,000.00	$      680,000.00	$      (102,000.00)

* Supervisor salary is avoidable fixed cost. It will be saved if carburetor is purchased from outside but depreciation will still be the same , so 2/3rd of fixed cost still occurs when Carburetor is purchased. Alternatively Depreciation could be excluded from both alternatives, the final would still be same.

Financial Disadvantage of $102000.00 if Carburetor is purchased from outside.

Answer 2

The Supplier's Offer should be Rejected, since it has higher cost than Manufacturing.

Answer 3

Statement of Cost Analysis
	Make	Buy	Incremental (cost) or benefit
Purchase Price	$                       -	$      544,000.00	$      (544,000.00)
Direct Material	$      238,000.00	$                       -	$        238,000.00
Direct labor	$      136,000.00	$                       -	$        136,000.00
Variable Manufacturing Overheads	$        51,000.00	$                       -	$          51,000.00
Fixed Manufacturing Overheads, Traceable	$        51,000.00	$        34,000.00	$          17,000.00
Fixed Manufacturing Overheads, Allocated	$      102,000.00	$      102,000.00	$                          -
	$      578,000.00	$      680,000.00	$      (102,000.00)

Total Extra cost in Buying carbonator	$   (102,000.00)
Less: Benefit to be achieved by accepting offer	$      170,000.00
Net (Cost) or benefit by acceptance of offer	$        68,000.00

Net Financial Advantage of Accepting the offer will be $68000.00.

Answer 4

The Offer should be Accepted Since Additional cost of Accepting offer is lower than additional benefits achieved by accepting the offer.