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 $30 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				13,000 Units Per Year
Direct materials	$	13		$	169,000
Direct labor		9			117,000
Variable manufacturing overhead		3			39,000
Fixed manufacturing overhead, traceable		3	*		39,000
Fixed manufacturing overhead, allocated		6			78,000
Total cost	$	34		$	442,000

*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 13,000 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 $130,000 per year. Given this new assumption, what would be financial advantage (disadvantage) of buying 13,000 carburetors from the outside supplier?

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

Answer 1

The variable cost of producing a carburetor is DM + DL + Variable manufacturing overhead + Fixed overhead expenses traceable to the machine = 13 + 9 + 3 + 3 = 28

It means that even if company purchases 13,000 carburetors from the supplier the company will be incurring a fixed expense of 78,000 irrespective.

Therefore the company will incure 30 -28 extra 2 variable cost per unit and also fixed expense of 78,000 =

13,000 x 2 + 78,000 = 1,04,000 financial disadvantage.

2. The supplier's offer should not be accepted.

3. Considering the calculation done above and if the company earns a margin of $130,000 then the company will be earning $26,000 (1330,000 - 104,000) more so it will have financial advantage of $26,000

4.Yes the suppliers offer shall be accepted keeping in mind the assumption made in part 3