Troy Engines, Ltd., manufactures a variety of engines for use in heavy equipment

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 $34 per unit. To evaluate this offer, Troy Engines, Ltd., has gathered the following information relating to its own cost of producing the carburetor internally:

*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 19,000 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 $190,000 per year. Given this new assumption, what would be financial advantage (disadvantage) of buying 19,000 carburetors from the outside supplier?

4. Given the new assumption in requirement 3, should the outside supplier’s offer be accepted?

Per Unit 19,000 Units
Per Year Direct materials $ 16 $ 304,000 Direct labor 10 190,000 Variable manufacturing overhead 2 38,000 Fixed manufacturing overhead, traceable 9 * 171,000 Fixed manufacturing overhead, allocated 12 228,000 Total cost $ 49 $ 931,000

Explanation / Answer

1) Total relevant cost :

Financial disadvantage = 589000-646000 = -57000

2) Reject

3) Total relevant cost :

Financial advantage = 133000

4) Accept

Make Buy Direct material 304000 Direct labour 190000 Variable manufacturing overhead 38000 Fixed manufacturing overhead (171000/3) 57000 Purchase cost (19000*34) 646000 Total relevant cost 589000 646000

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