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: 16,000 Units Per Year Per Unit Direct materials Direct labor Variable manufacturing overhead Fixed manufacturing overhead, traceable Fixed manufacturing overhead, allocated Total cost 13 208,000 13 208,000 32,000 9* 144,000 192,000 49 784,000 12 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

1 Per Unit Differential Costs 16,000 units Make Buy Make Buy Cost of purchasing $           35 $ 560,000 Direct materials $             13 $ 208,000 Direct labor                 13 $ 208,000 Variable manufacturing overhead                   2 $    32,000 Fixed manufacturing overhead, traceable1                   3 $    48,000 Fixed manufacturing overhead, common Total Costs $             31 $           35 $ 496,000 $ 560,000 Difference in favor of continuing to make the carburetors $               4 $    64,000 1 Only the supervisory salaries can be avoided if the carburetors are purchased. The remaining book value of the special equipment is a sunk cost; hence, the $6 per unit depreciation expense is not relevant to this decision. Based on these data, the company should reject the offer and should continue to produce the carburetors internally. 2 Make Buy Cost of purchasing (part 1) $560,000 Cost of making (part 1) $496,000 Opportunity cost—segment margin foregone on a potential new product line        160,000    Total cost $656,000 $560,000 Difference in favor of purchasing from the outside supplier $96,000 Thus, the company should accept the offer and purchase the carburetors from the outside supplier.

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