Troy Engines, Ltd., manufactures a variety of engines for use in heavy equipment

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 16,000 Units Per Year Direct materials $ 16 $ 256,000 Direct labor 12 192,000 Variable manufacturing overhead 3 48,000 Fixed manufacturing overhead, traceable 3 * 48,000 Fixed manufacturing overhead, allocated 6 96,000 Total cost $ 40 $ 640,000 *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 16,000 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 $160,000 per year. Given this new assumption, what would be financial advantage (disadvantage) of buying 16,000 carburetors from the outside supplier? 4. Given the new assumption in requirement 3, should the outside supplier’s offer be accepted?

Explanation / Answer

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Part-1 Make Buy Cost of purchasing 35 Direct Material 16 Direct Labor 12 Variable Manufacturing Overhead 3 Fixed Manufacturing Overhead, Traceable* 3*1/3 1 Fixed Manufacturing Overhead, Common 0 Total Cost per Unit 32 35 Units 16000 16000 Total Relevant Cost 512000 560000 Only Supervisor salary is avoidable, Depreciation can not be avoided and not relevant for the decision. Financial disadvantage of buying 560000-512000 -48000 Part-2 NO Part-3 Make Buy Cost of Making (From Part-1) 512000 Cost of Buying (From Part-1) 560000 Opportunity Cost-Loss of New Segment Margin 160000 Total Relevant Cost 672000 560000 Financial disadvantage of buying 672000-560000 112000 Part-4 Yes

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