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:

	Per Unit				17,000 Units per Year
Direct materials	$	17		$	289,000
Direct labor		8			136,000
Variable manufacturing overhead		4			68,000
Fixed manufacturing overhead, traceable		6	*		102,000
Fixed manufacturing overhead, allocated		9			153,000
Total cost	$	44		$	748,000

*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

Solution:

1.)

	Per unit Differential Costs		17,000 units
	Make	Buy	Make	Buy
Cost of purchasing		$35		$595,000
Direct materials	$17		$289000
Direct labor	$8		$136,000
Variable manufacturing overhead	$4		$68,000
Fixed manufacturing overhead, traceable	$2 (6 × 1/3)		$34,000
Fixed manufacturing overhead, common	-		-
Total costs	$31	$35	$527,000	$595,000
Difference in favor of continuing to make the carburetors		$4		$68,000

Financial (disadvantage) = $68,000

2.)

No, The company should not be accepted supplier's offer.

3.)

	Make	Buy
Cost of purchasing (see above part 1)		$595,000
Cost of making (see above part 1)	$527,000
Opportunity cost - segment margin forgone	$170,000
Total costs	$697,000	$595,000
Difference in favor of purchasing from outside supplier		$102,000

Financial advantage = $102,000

4.) Yes, Given the new assumption in requirement 3, the company should be accepted the supplier's offer.

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