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: Direct materials Direct labor Variable manufacturing overhead Fixed manufacturing overhead, traceable Fixed manufacturing overhead, allocated Total cost 15,000 Units Per Per Unit Year $ 14 $ 210,000 10 150,000 3 45,000 6* 90,000 9 135,000 $ 42 $ 630,000 = *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 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

1
Calculation of total cost of making and buying the product
	Make	Buy	Difference
Direct materials	$14.00
Direct labor	$10.00
Variable manufacturing overhead	$3.00
Fixed manufacturing overhead, traceable (6*(1/3))	$2.00
Fixed manufacturing overhead, allocated	$0.00
Cost of purchasing		$35.00
Total unit costs	$29.00	$35.00
Number of units produced per year	15000	15000
Total costs	$435,000	$525,000	-$90,000
In case of fixed manufacturing overhead traceable, depreciation expense would still continue even if company purchases the product and the supervisory salary can be avoided.
The financial disadvantage for buying the product from outside supplier is $90,000.
2
The cost of making the product is lower than purchase cost from the supplier and so company should reject the outside supplier's offer
3
	Make	Buy
Direct materials	$14.00
Direct labor	$10.00
Variable manufacturing overhead	$3.00
Fixed manufacturing overhead, traceable (6*(1/3))	$2.00
Fixed manufacturing overhead, allocated	$0.00
Cost of purchasing		$35.00
Total unit costs	$29.00	$35.00
Number of units produced per year	15000	15000
Total costs	$435,000	$525,000
Opportunity cost lost	$150,000
Total costs incurred	$585,000	$525,000	$60,000
The financial advantage for buying the product from outside supplier is $60,000.
4.
In this situation the outside supplier cost would be lower than inhouse costs and so company should accept the outside supplier's offer.