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 $39 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 21,000 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 $210,000 per year. Given this new assumption, what would be financial advantage (disadvantage) of buying 21,000 carburetors from the outside supplier? (Most Important)

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

Per Unit 21,000 Units
Per Year Direct materials $ 18 $ 378,000 Direct labor 11 231,000 Variable manufacturing overhead 3 63,000 Fixed manufacturing overhead, traceable 3 * 63,000 Fixed manufacturing overhead, allocated 6 126,000 Total cost $ 41 $ 861,000

Explanation / Answer

1.

3.

Make Buy Total relevant costs (21,000 units) $693,000 $   819,000 Per Unit 21,000 units Make Buy Make Buy Cost of purchasing $39 $819,000 Direct materials $           18 $378,000 Direct labor              11 $231,000 Variable manufacturing overhead                3 $63,000 Fixed manufacturing overhead, traceable ** ($3/3)                1 $21,000 Fixed manufacturing overhead, common 0       0              Total costs $33 $39 $693,000 $819,000 ($126,000) ($693000-$819000) ** Only the supervisory salaries can be avoided if the carburetors are purchased. The remaining book value of the special equipment is a sunk cost; hence, the $2 per unit depreciation expense is not relevant to this decision. There would be the financial disadvantage (loss) of buying 21,000 carburetors from the outside supplier of $126,000. 2. Should the outside supplier's offer be accepted? NO Based on these data, the company should reject the offer and should continue to produce the carburetors internally as Production cost of $33 is less than Purchase cost of $39.

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