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 $35 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				15,000 Units Per Year
Direct materials	$	14			$	210,000
Direct labor		10				150,000
Variable manufacturing overhead		3				45,000
Fixed manufacturing overhead, traceable		6	*			90,000
Fixed manufacturing overhead, allocated		9				135,000
Total cost	$	42			$	630,000

*One-third supervisory salaries; two-thirds depreciation of special equipment (no resale value).

Required:

1a. Assuming that the company has no alternative use for the facilities that are now being used to produce the carburetors, compute the total cost of making and buying the parts.

1b. Should the outside supplier’s offer be accepted?

	Accept
	Reject

2a. 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 $150,000 per year. Compute the total cost of making and buying the parts.

2b. Should Troy Engines, Ltd., accept the offer to buy the carburetors for $35 per unit?

	Accept
	Reject

Answer 1

Answer 1a	Statement of Cost Analysis(15000 Units)
		Make	Buy	Incremental (cost) or benefit
	Purchase Price	$                       -	$      525,000.00	$      (525,000.00)
	Direct Material	$      210,000.00	$                       -	$        210,000.00
	Direct labor	$      150,000.00	$                       -	$        150,000.00
	Variable Manufacturing Overheads	$        45,000.00	$                       -	$          45,000.00
	Fixed Manufacturing Overheads, Traceable*	$        90,000.00	$        60,000.00	$          30,000.00
	Fixed Manufacturing Overheads, Allocated	$      135,000.00	$      135,000.00	$                          -
		$      630,000.00	$      720,000.00	$        (90,000.00)

* 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 can be ignored in both cases and Supervisor salary can be shown as fixed cost when product is manufactured. In both cases final answer (Incremental Benefit) would be same.

Financial Disadvantage of $90000.00 if Carburetor is purchased from outside.

Answer 1b

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

Answer 2a	Statement of Cost Analysis
		Make	Buy	Icremental (cost) or benefit
	Purchase Price	$                       -	$      525,000.00	$      (525,000.00)
	Direct Material	$      210,000.00	$                       -	$        210,000.00
	Direct labor	$      150,000.00	$                       -	$        150,000.00
	Variable Manufacturing Overheads	$        45,000.00	$                       -	$          45,000.00
	Fixed Manufacturing Overheads, Traceable	$        90,000.00	$        60,000.00	$          30,000.00
	Fixed Manufacturing Overheads, Allocated	$      135,000.00	$      135,000.00	$                          -
		$      630,000.00	$      720,000.00	$        (90,000.00)

Total Extra cost in Buying carbonator	$      (90,000.00)
Less: Benefit to be achieved by accepting offer	$      150,000.00
Net (Cost) or benefit by acceptance of offer	$        60,000.00

Net Financial Advantage of Accepting the offer will be $60000.00.

Answer 2b

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