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 $32 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				17,000 Units per Year
Direct materials	$	14		$	238,000
Direct labor		8			136,000
Variable manufacturing overhead		3			51,000
Fixed manufacturing overhead, traceable		3	*		51,000
Fixed manufacturing overhead, allocated		6			102,000
Total cost	$	34		$	578,000

*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 17,000 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 $170,000 per year. Given this new assumption, what would be the financial advantage (disadvantage) of buying 17,000 carburetors from the outside supplier?

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

Answer 1

1. The financial advantage ( disadvantage) of buying 17,000 carburetors = $ ( 102,000)

	Make	Buy	Increase ( Decrease) in Net Operating Income
Relevant Costs
Direct Materials	238,000		238,000
Direct Labor	136,000		136,000
Variable Manufacturing Overhead	51,000		51,000
Supervisor Salaries	17,000		17,000
Purchase Cost		544,000	(544,000)
Total Relevant Costs	442,000	544,000	(102,000)

Depreciation, being an allocation of a sunk cost, is not considered to be a relevant cost.

2. No.

3. The financial advantage ( disadvantage) of buying 17,000 carburetors = $ 68,000.

4. Yes.