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 $ 16 $ 256,000 Direct labor 12 192,000 Variable manufacturing overhead 3 48,000 Fixed manufacturing overhead, traceable 3 * 48,000 Fixed manufacturing overhead, allocated 6 96,000 Total cost $ 40 $ 640,000 *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

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Part-1
		Make	Buy
Cost of purchasing			35
Direct Material		16
Direct Labor		12
Variable Manufacturing Overhead		3
Fixed Manufacturing Overhead, Traceable*	3*1/3	1
Fixed Manufacturing Overhead, Common		0
Total Cost per Unit		32	35
Units		16000	16000
Total Relevant Cost		512000	560000
Only Supervisor salary is avoidable, Depreciation can not be avoided and not relevant for the decision.
Financial disadvantage of buying	560000-512000	-48000
Part-2
NO
Part-3
		Make	Buy
Cost of Making (From Part-1)		512000
Cost of Buying (From Part-1)			560000
Opportunity Cost-Loss of New Segment Margin		160000
Total Relevant Cost		672000	560000
Financial disadvantage of buying	672000-560000	112000
Part-4
Yes