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). 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 23,000 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 $230,000 per year. Given this new assumption, what would be financial advantage (disadvantage) of buying 23,000 carburetors from the outside supplier? 4. Given the new assumption in requirement 3, should the outside supplier’s offer be accepted?

Answer 1

1
	Per unit		Total 23000 units
	Make	Buy	Make	Buy
Direct materials	16		368000
Direct labor	9		207000
Variable manufacturing overhead	4		92000
Fixed manufacturing overhead traceable	2		46000
Purchase cost		37		851000
Total			713000	851000
Difference in favor of making = 851000-713000 = $138000
Financial (disadvantage) $(138000)
2
Reject the offer
3
	Make	Buy
Total cost	713000	851000
Opportunity cost	230000
Total relevant cost	943000	851000
Difference in favor of buying = 851000-943000 = $92000
Financial advantage $92000
4
Accept the offer