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 $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:

*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 15,000 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 $150,000 per year. Given this new assumption, what would be financial advantage (disadvantage) of buying 15,000 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) avoidable cost direct material direct labor variable manufactu ring overhead Traceable fixed manfucturing overhead (supervision salary) 90000*1/3 Total avoidable cost Less purchase cost (15000*36) financial advantage/(disadvantage) 180000 180000 60000 30000 450000 -540000 -90000 2) No as it results in financial disadvantage of $9o000. 3) Total avoidable cost add segment margin of new product Less purchase cost (15000*36) financial advantage/(disadvantage) 450000 150000 540000 60000 4) Yes as it result in financial advantage of $60000.