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 $37 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				23,000 Units per Year
Direct materials	$	16		$	368,000
Direct labor		9			207,000
Variable manufacturing overhead		4			92,000
Fixed manufacturing overhead, traceable		6	*		138,000
Fixed manufacturing overhead, allocated		9			207,000
Total cost	$	44		$	1,012,000

*One-third supervisory salaries; two-thirds depreciation of special equipment (no resale value).

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 23,000 carburetors from the outside supplier?

Financial advantage or disadvantage?

$

Should the outside supplier’s offer be accepted? Yes or no

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 $230,000 per year. Given this new assumption, what would be the financial advantage (disadvantage) of buying 23,000 carburetors from the outside supplier?

Financial advantage or disadvantage

$

Given the new assumption in requirement 3, should the outside supplier’s offer be accepted? Yes or no

Answer 1

1) Differential analysis

	Make	buy
Direct material	368000
Direct labor	207000
Variable overhead	92000
Fixed overhead (138000/3)	46000
Purchase cost (23000*37)		851000
Total relevant cost	713000	851000

Financial (disadvantage) = 713000-851000 = -138000

2) No

2) Differential analysis

	Make	buy
Direct material	368000
Direct labor	207000
Variable overhead	92000
Fixed overhead (138000/3)	46000
Opportunity Cost	230000
Purchase cost (23000*37)		851000
Total relevant cost	943000	851000

Financial advantage = 943000-851000 = 92000

4) Yes