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				13,000 Units Per Year
Direct materials	$	13		$	169,000
Direct labor		9			117,000
Variable manufacturing overhead		3			39,000
Fixed manufacturing overhead, traceable		3	*		39,000
Fixed manufacturing overhead, allocated		6			78,000
Total cost	$	34		$	442,000

*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 13,000 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 $130,000 per year. Given this new assumption, what would be financial advantage (disadvantage) of buying 13,000 carburetors from the outside supplier?

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

Answer 1

Calculation of Relevant cost for decision making	:
Particulars	Amount($)
Direct materials	13
Direct labor	9
Variable manufacturing overhead	3
Fixed manufacturing overhead, traceable	3
Fixed manufacturing overhead, allocated	0
Cost/unit	28
Cost of Manufacturing 13000 units	364000
Cost of Outsourcing Per unit	30
Cost of Outsourcing 13000 units	390000
1.Financial Disadvantage of outsourcing	26000
Note:
a)Fixed manufacturing overhead, traceable incurred specifically for manufacturing carburetor internally which can be avoided by outsourcing hence relevant for decision making
b)Fixed manufacturing overhead, allocated not specifically for manufacturing carburetor internally which can not be avoided by outsourcing hence not relevant for decision making

2. Since Cost of outsourcing is higher by $ 26000 it is advisable to manufacture the product internally

3. If Company outsources the Carburetors and utilise the freed capacity for launching new product

Savings in cost of not manufacturing = $13000*28 = $3,64,000

Cost of Outsourcing = $13000*30 = $3.90,000

Segment margin of the new product would be $130,000 per year

Financial Advantage = $3,64,000-3,90,000+1,30,000=$1,04,000

4.

Since Otsourcing the component and using the Freed Capacity for launching new product results in Financial advantage it is Preferable to accept the Outside Supplier's Offer