Question

Exercise 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 $33 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 18,000 Units Per Year Direct materials $ 15 $ 270,000 Direct labor 9 162,000 Variable manufacturing overhead 4 72,000 Fixed manufacturing overhead, traceable 6 * 108,000 Fixed manufacturing overhead, allocated 9 162,000 Total cost $ 43 $ 774,000 *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 18,000 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 $180,000 per year. Given this new assumption, what would be financial advantage (disadvantage) of buying 18,000 carburetors from the outside supplier? 4. Given the new assumption in requirement 3, should the outside supplier’s offer be accepted?

Answer 1

1) Relevant Traceable Fixed manufacturing overhead per unit = $6*1/3 = $2 per unit (supervisor salaries)

Total Relevant manufacturing cost per unit = Material+Labor+Variable manufacturing OH+Traceable manuf. OH

= $15+$9+$4+$2 = $30 per unit

Cost of buying from outside supplier = $33 per unit

Net disadvantage in buying carburetors from outsider = ($33 per unit - $30 per unit)*18,000 units

= $3 per unit*18,000 units = $54,000

(two third depreciation will not included in the relevant traceable manufacturing overhead because special equipment has no resale value)

2) As there is a net disadvantage of $54,000 in buying carburetors from outside supplier, the offer should not be accepted.

3) Total Additional margin from new product = $180,000

Additional margin per unit = $180,000/18,000 units = $10 per unit

Relevant cost of buying from outside supplier = Buying cost - Additional margin

= $33 per unit - $10 per unit = $23 per unit

Relevant manufacturing cost = $30 per unit

Net Advantage in buying from outside = ($30 per unit - $23 per unit)*18,000 units

= $7 per unit*18,000 units = $126,000

4) As there is a net advantage of $126,000 in buying carburetors from outside supplier, the offer should be accepted.