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 19,000 Units Per Year Direct materials $ 16 $ 304,000 Direct labor 10 190,000 Variable manufacturing overhead 2 38,000 Fixed manufacturing overhead, traceable 9 * 171,000 Fixed manufacturing overhead, allocated 12 228,000 Total cost $ 49 $ 931,000 *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 19,000 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 $190,000 per year. Given this new assumption, what would be the financial advantage (disadvantage) of buying 19,000 carburetors from the outside supplier?

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

Answer 1

Solution:

1.) Different analysis

	Make	Buy
Direct material	$304,000
Direct labor	$190,000
Variable overhead	$38,000
Fixed overhead ($171,000/3)	$57,000
Purchase cost (19,000 × $34)		$646,000
Total relevant cost	$589,000	$646,000

Financial (disadvantage) = $589, 000 - $646,000

=-$57,000

2.) No, the outside supplies offer should not be accepted.

3.) Different analysis:

	Make	Buy
Direct material	$304,000
Direct labor	$190,000
Variable overhead	$38,000
Fixed overhead ($171,000/3)	$57,000
Opportunity cost	$190,000
Purchase cost (19, 000 × $34)		$646,000
Total relevant cost	$779,000	$646,000

Financial advantage = $779,000 - $646,000

=$133,000

4.) Yes, give the new assumption in requirement, the outside supplier's offer should be accepted.