Question

xercise 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				15,000 Units Per Year
Direct materials	$	12		$	180,000
Direct labor		12			180,000
Variable manufacturing overhead		4			60,000
Fixed manufacturing overhead, traceable		6	*		90,000
Fixed manufacturing overhead, allocated		9			135,000
Total cost	$	43		$	645,000

*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 15,000 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 $150,000 per year. Given this new assumption, what would be the financial advantage (disadvantage) of buying 15,000 carburetors from the outside supplier?

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

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 15,000 carburetors from the outside supplier?

REQUIRED 2. 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. Given this new assumption, what would be the financial advantage (disadvantage) of buying 15,000 carburetors from the outside supplier?

Answer 1

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Troy Engines Ltd.

To check whether to buy at $ 36 or not we have to check the relevant cost of the product.

Particulars	Per unit	Remarks	Remarks
Direct materials	12.00	Relevant	It is a unit level cost so relevant.
Direct Labor	12.00	Relevant	It is a unit level cost so relevant.
Variable Manufacturing overhead	4.00	Relevant	It is a unit level cost so relevant.
Fixed Manufacturing overhead	2.00	Relevant	Total is $ 6. But 1/3rd is supervisor salary which is relevant because if product is purchased then there is no super vison cost on production. 2/3 is equipment depreciation which is always irrelevant and sunk cost.

Answer 1
Relevant cost per unit of a Carburetor:
Particulars	Amount $
Direct materials	12.00
Direct Labor	12.00
Variable Manufacturing overhead	4.00
Fixed Manufacturing overhead	2.00
Relevant cost per unit of a product	30.00
Less: Price quoted by vendor	36.00
Loss per unit	(6.00)	A
Number of units	15,000.00	B
Financial disadvantage	(90,000.00)	C=A*B

Answer 2

Right now the relevant cost is $ 30 while the vendor is giving the same product at $ 36. So there is a loss of $ 6. Hence proposal should not be accepted as Troy Engines will lose $ 90,000 in total.

Answer 3
Financial disadvantage if capacity is idle	(90,000.00)
Add: Segment margin of new product	150,000.00
Financial Advantage	60,000.00

Answer 4

If new product is launched then Troy Engines will have net Financial advantage of $ 60,000. So then the proposal can be accepted.