Troy Engines, Ltd., manufactures a variety of engines for use in heavy equipment
ID: 2468377 • Letter: T
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 15,000
Units Per Year
Direct materials $ 14 $ 210,000
Direct labor 10 150,000
Variable manufacturing overhead 3 45,000
Fixed manufacturing overhead, traceable 6* 90,000
Fixed manufacturing overhead, allocated 9 135,000
Total cost $ 42 $ 630,000
*One-third supervisory salaries; two-thirds depreciation of special equipment (no resale value).
Required: 1a. Assuming that the company has no alternative use for the facilities that are now being used to produce the carburetors, compute the total cost of making and buying the parts.
1b. Should the outside supplier’s offer be accepted?
2a. 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. Compute the total cost of making and buying the parts.
2b. Should Troy Engines, Ltd., accept the offer to buy the carburetors for $35 per unit?
Explanation / Answer
1a. Direct material 14
Direct Labor 10
Variable manufacturing overhead 3
Fixed manufacturing overhead 2
--------------
Total relevant cost per unit $ 29
Fixed manufacturing overhead = Supervisory salaries 1/3 x 6 = 2
Total relevant cost for 15,000 unit = 29 x 15,000 = $ 435,000
1b. The outside supplier’s offer should be rejected. Because the cost of making $ 29 per unit is less than cost of buying $ 35 per unit.
2a. Relevant cost = Total cost of manufacturing + opportunity cost
= 435,000 + 150,000 = $ 585,000
2b. Troy Engines, Ltd., should accept the offer to buy the carburetors for $35 per unit as purchase from outside 35 x 15,000 = $ 525,000 is cheaper than making cost $ 585,000 .
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