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				20,000 Units Per Year
Direct materials	$	17		$	340,000
Direct labor		11			220,000
Variable manufacturing overhead		3			60,000
Fixed manufacturing overhead, traceable		3	*		60,000
Fixed manufacturing overhead, allocated		6			120,000
Total cost	$	40		$	800,000

*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 20,000 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 $200,000 per year. Given this new assumption, what would be financial advantage (disadvantage) of buying 20,000 carburetors from the outside supplier?

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

Answer 1

1	The financial advantage (disadvantage) of buying 20,000 carburetors from the outside supplier
	Cost of carborator from outside supplier=	=35*20000	7,00,000
	Add: Depreciation Cost	=60000*2/3	40,000
	Total Cost of buying the carburator from outside		7,40,000
	Total cost for manufacturing the carborator		8,00,000
	Financial Advantage of Buying from outside supplier		60,000
	Note- Even if the company is buying the product from outside the company has to bear deprecuation charges.
2	Yes the company should accept the outside suppliers offer as there is net gain of 60000.
3	Segment Margin of the new Product Manufactured		200000
	Less- Fixed Manufacturing Overhaed Traceable		60000
	Less- Fixed Manufacturing Overhaed Allocated		120000
	Net Profit		20000
	Less: Loss from buying the product from outside		80000
	=Variable Cost of Manufacturing-Cost of buying from outside
	=620000-700000
	Net Loss		-60000
	Note- Since the company is manufacturing new product all the fixed expenses will be considered for calculating net profit or loss of manufacturing new product.
	And only variable cost will be considered for calculating the cost of buying the product from outsid supplier.
4	Giventhe above situation in 3 the outside suppliers offer should not be accepted as there is net loss.
	Note-
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