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 $32 per unit. To evaluate this offer, Troy Engines, Ltd., has gathered the following information relating to its own cost of producing the carburetor internally: Direct materials Direct labor Variable manufacturing overhead Fixed manufacturing overhead, traceable Fixed manufacturing overhead, allocated Total cost 17,000 Units Per per Unit Year $ 14 $ 238,000 8 136,000 3 51,000 3* 51,000 6 102,000 $ 34 $ 578,000 *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 17,000 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 $170,000 per year. Given this new assumption, what would be the financial advantage (disadvantage) of buying 17,000 carburetors from the outside supplier? 4. Given the new assumption in requirement 3, should the outside supplier's offer be accepted?

Answer 1

Required 1 :
	Make	Buy
Direct materials	238000
Direct labor	136000
Variable manufacturing overhead	51000
Buying cost ( 17000 * 32 )		544000
Fixed manufacturing overhead, traceable ( Supervisor's salary = 51000 * 1/3 )	17000
Total relevant cost	442000	544000

Note : Allocated fixed manufacturing overhead and depreciation of special equipment will appear in both the situations and will not affect the decision marking and hence the same is ignored in the calculation.

Total relevant cost of making	442000
Less : Total relevant cost of buying	544000
Financial advantage (Disadvantage)	(102000)

Required 2 :

Answer : No

Reason : As the outside supplier's offer is resulting in a financial disadvantage

Required 3 :
	Make	Buy
Direct materials	238000
Direct labor	136000
Variable manufacturing overhead	51000
Buying cost ( 17000 * 32 )		544000
Fixed manufacturing overhead, traceable ( Supervisor's salary = 51000 * 1/3 )	17000
Less: Segment margin of the new product		170000
Total relevant cost	442000	374000

Total relevant cost of making	442000
Less : Total relevant cost of buying	374000
Financial advantage (Disadvantage)	68000

Required 4 :

Answer : Yes

Reason : As the outside supplier's offer is resulting in a financial advantage