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 $39 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				21,000 Units Per Year
Direct materials	$	18		$	378,000
Direct labor		11			231,000
Variable manufacturing overhead		3			63,000
Fixed manufacturing overhead, traceable		3	*		63,000
Fixed manufacturing overhead, allocated		6			126,000
Total cost	$	41		$	861,000

*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 21,000 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 $210,000 per year. Given this new assumption, what would be financial advantage (disadvantage) of buying 21,000 carburetors from the outside supplier?

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

Answer 1

1.
Calculation of increase or decrease in profit if outside supplier's offer is accepted
	Make	Buy
Cost of purchasing from outside supplier (21000*39)		$819,000
Direct material cost (21000*18)	$378,000
Direct labor cost (21000*11)	$231,000
Variable manufacturing overhead (21000*3)	$63,000
Fixed manufacturing overhead ((21000*3)/3)	$21,000
Total costs incurred	$693,000	$819,000
The 2/3rd of fixed cost would continue even if the company purchases the product and therefore is not relevant for decision making and so balance 1/3rd of fixed cost is considered.
If company makes the product the cost is	$693,000
If company buys the product the cost is	$819,000
Savings in cost if product is purchased	-$126,000
The financial disadvantage of buying 21,000 carburetors from the outside supplier is $126,000.
2.
The company should not accept the outside supplier's offer as the profit would decrease by $126,000.
3.
Calculation of increase or decrease in profit if outside supplier's offer is accepted
	Make	Buy
Cost of purchasing from outside supplier (21000*39)		$819,000
Direct material cost (21000*18)	$378,000
Direct labor cost (21000*11)	$231,000
Variable manufacturing overhead (21000*3)	$63,000
Fixed manufacturing overhead ((21000*3)/3)	$21,000
Opportunity costs (new product margin)	$210,000
Total costs incurred	$903,000	$819,000
The 2/3rd of fixed cost would continue even if the company purchases the product and therefore is not relevant for decision making and so balance 1/3rd of fixed cost is considered.
If company makes the product the cost is	$903,000
If company buys the product the cost is	$819,000
Savings in cost if product is purchased	$84,000
The financial advantage of buying carburetors from the outside supplier is $84,000.
4.
The company should accept the outside supplier's offer as the profit would increase by $84,000