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				16,000 Units Per Year
Direct materials	$	13		$	208,000
Direct labor		13			208,000
Variable manufacturing overhead		2			32,000
Fixed manufacturing overhead, traceable		9	*		144,000
Fixed manufacturing overhead, allocated		12			192,000
Total cost	$	49		$	784,000

*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

1.

Statement of comparative cost	Make	Buy
Cost of purchasing		35
Direct material	13
Direct labor	13
variable manufacturing overhead	2
Fixed manufacturing overhead, traceable*	3
Fixed manufacturing overhead, allocated	0
Total cost per unit	31	35
Total relevant cost ( 16000 units)	496000	560000
	31 x 16000	35 x 16000

Disadvantage of buying from putside supplier = $496,000 - 560,000 =( $64,000)

* Only supervisory salaries can be avoided if the carburetors are purchased. The remaining book value of the special equipment is a sunk cost, hence not relvant for the decision.

2.

No , outside supplier should not be accepted

3.

Statement of comparative cost	Make	Buy
Cost of making	496000	560000
Cost of buying
Add: opportuinity cost - new product margin	160000
Total relevant cost ( 16000 units)	656000	560000

Advantage of buying from outside supplier = $656,000 - 560,000 = $96,000

4.

Yes outside supplier offer should be accepted