Question

Troy Engines, Ltd., manufactures a variety of engines for use in heavy equipment. The company has always produced all of the necessary parts 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 $36 per unit. To evaluate this offer, Troy Engines, Ltd., has gathered the following information relating to its own cost of producing the carburetor internally:

Per unit, 20,000 Units
Per Year

Direct materials$13 , $260000

Direct labor $11  ,$220,000

Variable manufacturing overhead $4,  $80,000

Fixed manufacturing overhead, traceable $6* $120,000

Fixed manufacturing overhead, allocated $9 , $180,000

Total cost$43 $860,000

*One-third supervisory salaries; two-thirds depreciation of special equipment (no resale value).

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 Carburetor or Buying Carburetor
Particulars	Making Carburetor	Buying Carburetor	Financial advantage (Disadvantage) of buying Carburetor
Costs:
Purchase Price (20000*$36)	$0	$7,20,000	-$7,20,000
Direct material	$2,60,000	$0	$2,60,000
Direct Labor	$2,20,000	$0	$2,20,000
Variable overhead	$80,000	$0	$80,000
Avoidable Fixed Overhead ($120,000*1/3)	$40,000	$0	$40,000
Total Cost	$6,00,000	$7,20,000	-$1,20,000

Disadvantage = - $120,000

Solution 2:

No, Outside supplier's offer should not be accepted.

Solution 3:

Differential Analysis - Making Carburetor or Buying Carburetor
Particulars	Making Carburetor	Buying Carburetor	Financial advantage (Disadvantage) of buying Carburetor
Costs:
Purchase Price (20000*$36)	$0	$7,20,000	-$7,20,000
Direct material	$2,60,000	$0	$2,60,000
Direct Labor	$2,20,000	$0	$2,20,000
Variable overhead	$80,000	$0	$80,000
Avoidable Fixed Overhead ($120,000*1/3)	$40,000	$0	$40,000
Loss of opportunity of new product margin	$2,00,000	$0	$2,00,000
Total Cost	$8,00,000	$7,20,000	$80,000

Advantage = $80,000

Solution 4:

Yes, Outside supplier's offer should be accepted.