Question

Exercise 12-3 Make or Buy Decision (LO12-3] 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: Direct materials Direct labor Variable manufacturing overhead Fixed manufacturing overhead, traceable Fixed manufacturing overhead, allocated Total cost 20,000 Units Per Per Unit Year $ 17 $ 340,000 11 220,000 3 60,000 3* 60,000 6 120,000 $ 40 $ 800,000 *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 20,000 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 $200,000 per year. Given this new assumption, what would be the financial advantage (disadvantage) of buying 20,000 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:

Differential Analysis- Troy Engines Ltd - Making Carbureator (alt 1) or Buying Carbureator (Alt2)
Particulars	Making Carbureator (Alt 1)	Buying Carbureator (Alt 2)	Financial advantage (Disadvantage) of buying (Alternative 2)
Costs:
Purchase Price (20000*$35)	$0.00	$700,000.00	-$700,000.00
Direct material	$340,000.00	$0.00	$340,000.00
Direct Labor	$220,000.00	$0.00	$220,000.00
Variable overhead	$60,000.00	$0.00	$60,000.00
Avoidable Fixed Overhead ($60,000*1/3)	$20,000.00	$0.00	$20,000.00
Total Cost	$640,000.00	$700,000.00	-$60,000.00

Solution 2:

As there is net financial disadvantage, therefore outside supplier offer should not be accepted.

Solution 3:

Differential Analysis- Troy Engines Ltd - Making Carbureator (alt 1) or Buying Carbureator (Alt2)
Particulars	Making Carbureator (Alt 1)	Buying Carbureator (Alt 2)	Financial advantage (Disadvantage) of buying (Alternative 2)
Costs:
Purchase Price (20000*$35)	$0.00	$700,000.00	-$700,000.00
Direct material	$340,000.00	$0.00	$340,000.00
Direct Labor	$220,000.00	$0.00	$220,000.00
Variable overhead	$60,000.00	$0.00	$60,000.00
Avoidable Fixed Overhead ($60,000*1/3)	$20,000.00	$0.00	$20,000.00
Loss of opportunity of new product margin	$200,000.00	$0.00	$200,000.00
Total Cost	$840,000.00	$700,000.00	$140,000.00

Solution 4:

As there is net financial advantage, therefore outside supplier offer should be accepted.