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 $36 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				20,000 Units per Year
Direct materials	$	17		$	340,000
Direct labor		10			200,000
Variable manufacturing overhead		2			40,000
Fixed manufacturing overhead, traceable		9	*		180,000
Fixed manufacturing overhead, allocated		12			240,000
Total cost	$	50		$	1,000,000

*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 20,000 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 $200,000 per year. Given this new assumption, what would be the financial advantage (disadvantage) of buying 20,000 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 20000 units
	Make	Buy	Make	Buy
Direct materials	17		340000
Direct labor	10		200000
Variable manufacturing overhead	2		40000
Fixed manufacturing overhead traceable	3		60000
Purchase cost		36		720000
Total			640000	720000
Difference in favor of making = 640000-720000 = $(80000)
Financial (disadvantage) $(80000)
2
Reject the offer
3
	Make	Buy
Total cost	640000	720000
Opportunity cost	200000
Total relevant cost	840000	720000
Difference in favor of buying = 840000-720000 = $120000
Financial advantage $120000
4
Accept the offer