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 $39 per unit. To evaluate this offer, Troy Engines, Ltd., has gathered the following information relating to its own cost of producing the carburetor internally: 21,000 Units Per Year Per Unit Direct materials Direct labor Variable manufacturing overhead Fixed manufacturing overhead, traceable Fixed manufacturing overhead, allocated Total cost s 18 $ 378,000 11 231,000 63,000 3* 63,000 126,000 41 861,000 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 21,000 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 $210,000 per year. Given this new assumption, what would be financial advantage (disadvantage) of buying 21,000 carburetors from the outside supplier? 4. Given the new assumption in requirement 3, should the outside supplier's offer be accepted?

Explanation / Answer

Answer:-a)-

If the company has no alternative facilities that are now being used to produce the carburetoes, the financial disadvantages of buying 21000 carburetors from outside supplier is ($39 per unit -$33 per unit)*21000 units =$126000.

b)-The offer from outside supplier should not be accepted.

c)-But product is purchase from outside supplier then Troy Engines ltd. Can use freed capacity to launch a new product & segment margin of the new product would be $210000.

Hence net benefit will be =Benefit from new product-Loss in purchase from supplier

                                          =$210000-$126000 =$84000

The financial advantages of buying 21000 carburetors from outside supplier willl be $84000.

Hence offer from outside supplier's should be accepted

Explanation:- 1)-In fixed manufacturing overhead, traceable only supervisory salaries will be taken for decision making, it is considered as a avoidable cost and relevant for decision making. Depreciation on special equipment is a sunk cost hence it is not a relevant cost, hence not considered.

2)- Fixed manufacturing overhead allocated are unavoidable fixed cost hence not considered in relevant cost, it is continue to occur whether to manufacture the product or buy the product.

Troy Engines Ltd. Statement of comprative cost Manufaturing Amount Purchase from outside Amount Per unit $ Per unit $ Direct Material        18.00 Purchase Cost        39.00 Direct Labor        11.00 Vaiable Manufaturing Overhead          3.00 Fixed Manufaturing overhead traceable ($3*1/3)          1.00 Total Manufaturing cost        33.00 Total Purchase cost        39.00

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