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				14,000 Units Per Year
Direct materials	$	14		$	196,000
Direct labor		10			140,000
Variable manufacturing overhead		4			56,000
Fixed manufacturing overhead, traceable		6	*		84,000
Fixed manufacturing overhead, allocated		9			126,000
Total cost	$	43		$	602,000

*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 14,000 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 $140,000 per year. Given this new assumption, what would be the financial advantage (disadvantage) of buying 14,000 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 14000 units
	Make	Buy	Make	Buy
Direct materials	14		196000
Direct labor	10		140000
Variable manufacturing overhead	4		56000
Fixed manufacturing overhead traceable	2		28000
Purchase cost		35		490000
Total			420000	490000
Difference in favor of making = 420000-490000 = $70000
Financial (disadvantage) (70000)
1b
No, Reject the offer
3
	Make	Buy
Total cost	420000	490000
Opportunity cost	140000
Total relevant cost	560000	490000
Difference in favor of buying = 560000-490000 = $70000
Financial advantage 70000
4
Yes, Accept the offer