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 16,000 Units Per Year Direct materials $ 13 $ 208,000 Direct labor 13 208,000 Variable manufacturing overhead 2 32,000 Fixed manufacturing overhead, traceable 9 * 144,000 Fixed manufacturing overhead, allocated 12 192,000 Total cost $ 49 $ 784,000 *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 16,000 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 $160,000 per year. Given this new assumption, what would be financial advantage (disadvantage) of buying 16,000 carburetors from the outside supplier? 4. Given the new assumption in requirement 3, should the outside supplier’s offer be accepted? =

Answer 1

		Per Unit Differential Costs
1				16000 Units
		Make	Buy	Make	Buy
	Cost of purchasing		35		560000
	Direct materials	13		208000
	Direct labor	13		208000
	Variable manufacturing overhead	2		32000
	Fixed manufacturing overhead, traceable1	3		48000
	Fixed manufacturing overhead, common	-		-	-
	Total Costs	31	35	496000	560000
	Difference in favor of continuing to make the carburetors	$4		$64,000
	1 Only the supervisory salaries can be avoided if the carburetors are purchased. The remaining book value of the special equipment is a sunk cost hence, the $6 per unit depreciation expense is not relevant to this decision.
2	Company should reject the offer
3		Make	Buy
	Cost of purchasing (part 1)		560000
	Cost of making (part 1)	496000
	Opportunity cost—segment margin forgone on a potential new product line	160000
	Total cost	656000	560000
	Difference in favor of purchasing from the outside supplier	96000
4	Thus, the company should accept the offer and purchase the carburetors from the outside supplier.

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