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 $34 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	$	14		$	294,000
Direct labor		12			252,000
Variable manufacturing overhead		2			42,000
Fixed manufacturing overhead, traceable		9	*		189,000
Fixed manufacturing overhead, allocated		12			252,000
Total cost	$	49		$	1,029,000

*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?

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?

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 the financial advantage (disadvantage) of buying 21,000 carburetors from the outside supplier?

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Answer 1

1) Differential analysis :

	Make	Buy
Direct material	294000
Direct labour	252000
Variable manufacturing overhead	42000
Fixed manufacturing overhead (189000/3)	63000
Purchase cost (21000*34)		714000
Total relevant cost	651000	714000

Financial disadvantage = 651000-714000 = -63000

2) No, Outside supplier's offer should not accepted

3) Differential analysis :

	Make	Buy
Direct material	294000
Direct labour	252000
Variable manufacturing overhead	42000
Fixed manufacturing overhead (189000/3)	63000
Opportunity cost	210000
Purchase cost (21000*34)		714000
Total relevant cost	861000	714000

Financial advantage = 861000-714000 = 147000

4) yes, Outside supplier's offer should accepted