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 $35 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		15,000 Units Per Year
Direct materials	$	14	$	210,000
Direct labor		10		150,000
Variable manufacturing overhead		3		45,000
Fixed manufacturing overhead, traceable		6*		90,000
Fixed manufacturing overhead, allocated		9		135,000
Total cost	$	42	$	630,000

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

   

Required:

1a.	Assuming that the company has no alternative use for the facilities that are now being used to produce the carburetors, compute the total cost of making and buying the parts.

    

      

1b.

Should the outside supplier’s offer be accepted?

	Accept
	Reject

    

2a.	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 $150,000 per year. Compute the total cost of making and buying the parts.

   

      

2b.

Should Troy Engines, Ltd., accept the offer to buy the carburetors for $35 per unit?

	Accept
	Reject

Answer 1

1a.

	Make	Buy
Total Relevant Cost	$ 435,000	$ 525,000

Total relevant cost of Make = Total Variable Manufacturing Cost + Supervisor Salaries = 15,000 x $ ( 14 + 10 + 3) + $ 90,000 / 3 = $ 435,000.

Total relevant cost of Buy = 15,000 x $ 35 = $ 525,000.

Depreciation is not relevant as it is allocation of a sunk cost.

1b. Reject.

2a.

	Make	Buy
Total Relevant Cost	$ 585,000	$ 525,000

Total relevant cost to Make = Total Variable Manufacturing Cost + Supervisor Salaries + Opportunity Cost = $ 405,000 + $ 30,000 + $ 150,000 = $ 585,000.

Total relevant cost to Buy = 15,000 x $ 35 = $ 525,000.

2b. Accept.