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 the 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

		Relevant Cost for 16000 Units
1)	Item	Make	Buy	Financial disadvantage
	Direct Material	208000
	Direct Labor	208000
	Variable Manufacturing Overhead	32000
	Fixed manufacturing Overhead(Supervisor salary)	48000
	Cost of purchsing from outside supplier		560000
	Total Cost	496000	560000	(64,000)
2)	No. Offer should not be accepted
3)		Relevant Cost for 16000 Units
	Item	Make	Buy	Financial Advantage
	Direct Material	208000
	Direct Labor	208000
	Variable Manufacturing Overhead	32000
	Fixed manufacturing Overhead(Supervisor salary)	48000
	Cost of purchsing from outside supplier		560000
	Benefit from launchinh new product		-160000
	Total Cost	496000	400000	96,000
4)	Yes Offer shoulld be accepted