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 $30 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				19,000 Units per Year
Direct materials	$	12		$	228,000
Direct labor		10			190,000
Variable manufacturing overhead		3			57,000
Fixed manufacturing overhead, traceable		3	*		57,000
Fixed manufacturing overhead, allocated		6			114,000
Total cost	$	34		$	646,000

*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 19,000 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 $190,000 per year. Given this new assumption, what would be the financial advantage (disadvantage) of buying 19,000 carburetors from the outside supplier?

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

The Regal Cycle Company manufactures three types of bicycles—a dirt bike, a mountain bike, and a racing bike. Data on sales and expenses for the past quarter follow:

	Total			Dirt Bikes			Mountain Bikes			Racing Bikes
Sales	$	927,000		$	269,000		$	401,000		$	257,000
Variable manufacturing and selling expenses		465,000			111,000			194,000			160,000
Contribution margin		462,000			158,000			207,000			97,000
Fixed expenses:
Advertising, traceable		69,000			8,500			40,300			20,200
Depreciation of special equipment		43,500			20,800			7,600			15,100
Salaries of product-line managers		114,100			40,400			38,400			35,300
Allocated common fixed expenses*		185,400			53,800			80,200			51,400
Total fixed expenses		412,000			123,500			166,500			122,000
Net operating income (loss)	$	50,000		$	34,500		$	40,500		$	(25,000)

*Allocated on the basis of sales dollars.

Management is concerned about the continued losses shown by the racing bikes and wants a recommendation as to whether or not the line should be discontinued. The special equipment used to produce racing bikes has no resale value and does not wear out.

Required:

1. What is the financial advantage (disadvantage) per quarter of discontinuing the racing bikes?

2. Should the production and sale of racing bikes be discontinued?

3. Prepare a properly formatted segmented income statement that would be more useful to management in assessing the long-run profitability of the various product lines.

Answer 1

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