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: Direct materials Direct labor Variable manufacturing overhead Fixed manufacturing overhead, traceable Fixed manufacturing overhead, allocated Total cost 16,000 Units Per Per Unit Year $ 16 $ 256,000 12192.000 3 48,000 3* 48,000 6 96,000 $ 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 the 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?

Answer 1

Answer to Question

1. If company has no alternative use of facility that now being used to produce the carburettors then following Financial advantages of buying 16000 carburettors from outside supplier

Advantages

1. Free space can be rent out
2. Can be used such space for production of different profitable product

Disadvantages

1. Quality may be compromised
2. Reliability of product and defect in product may result in goodwill loss or market share reduction.
3. Outsider supplier offer

Outsider supplier offer should be rejected as cost of production in house is less than buying from market

Particulars	In house cost per unit	Cost of buying per unit
Direct Material	16	0
Direct Labour	12	0
Variable Manufacturing Overheads	3	0
Fixed Manufacturing overheads, traceable	3	0
Market rate	0	35
Cost per unit	34	35

Note :

Fixed Manufacturing overheads is traceable and it’s not avoidable cost so, its part of production cost

Fixed manufacturing overheads allocated so not part of production cost

3. Suppose carbonators purchased and free capacity used to lunch new product and at profit margin would be $16000 per year

               

following Financial advantages (Disadvantages) of buying 16000 carburettors from outside supplier

1. increase in profit due to using free capacity to lunch new profitable products
2. if there any issue in product then we can claim for damages

4. As per new assumption in requirement 3

Here Troy Engines, Ltd will accept the outsider supplier offer as using free space for lunching new product result in increase in profit

If carbonators purchased then increments cost is $(35-34) *16000 units	$16,000
increments Revenue from free capacity used to lunch new product	$160,000
Increase in profit	$144,000