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:

	Per Unit				20,000 Units Per Year
Direct materials	$	17		$	340,000
Direct labor		10			200,000
Variable manufacturing overhead		2			40,000
Fixed manufacturing overhead, traceable		9	*		180,000
Fixed manufacturing overhead, allocated		12			240,000
Total cost	$	50		$	1,000,000

*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

1- a.Troy engines Ltd.
	Make	Buy	Differential
Purchase Price		36	115
DM	17		17
DL	10		10
Var. FOH	2		2
Supervisor salary ( 9 * 1/3 )	3		3
Total Relevant cost	32	36	4
Total relevant cost ( 20000 units )	640000	720000	80000
Note :-Supervisor salary is the relevant cost while making the decision while depreciation
of special equipment is irrelevant as it has nothing to do with decision making. It will occur
whether or not the product is made. Allocated Fixed manufacturing OH is also irrelevant
as it will continue to occur irrespective of the carburetor production.
1- b. No, the outsider's supplier should not be accepted as the same work can be done inhouse
resulting in a cost saving of $ 80000.
a.Total differential cost
	Making	Buying
Cost	640000	720000
Opp. Cost	200000
	840000	720000	120000
b. Troy engines Ltd. Should accept the offer to buy the carburetors @ $ 36 p.u as it will increase the profits
by $ 120,000.