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 $37 per unit. To evaluate this offer, Troy Engines, Ltd., has gathered the following information relating to its own cost of producing the carburetor internally: 23,800 Units Direct materials Direct labor Variable manufacturing overhead Fixed manufacturing overhead, traceable Fixed manufacturing overh Total cost Unit Per Year $ 16 $ 368,999 207, e00 92,e00 6" 138 207, ee6 $44 $1,012,899 , ead, allocated 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 23,000 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 $230,000 per year. Given this new assumption, what would be financial advantage (disadvantage) of buying 23,000 carburetors from the outside supplier? 4. Given the new assumption in requirement 3, should the outside supplier's offer be accepted? Complete this question by entering your answers in the tabs below. Required 1 Required 2 Required 3Required 4 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 23,000 carburetors from the outside supplier?

Explanation / Answer

1. Calculation of avoidable manufacturing cost per unit

Note: Fixed Manufacturing Overheads are required to be incurred irrespective of the level of output and therefore, it is unavoidable cost and is not relevant for decision making.

Outside supplier Cost = $37 per unit

Financial Advantage/ Disadvantage = (Relevant cost of manufacturing inhouse - Outside supplier cost) x 23,000 units

= (29 - 37) x 23,000 = -$184,000

Financial Disadvantage of $184,000

2. NO outside supplier offer should not be accepted as it leads to financial disadvantage.

3. Calculation of Outside Suuplier's net cost.

If outside supplier offer is accepted it, new product margin would be $230,000 which is (230,000 / 23,000) = $10 per unit. Hence the relevant cost of outside supplier will be:

Relevant cost of outside supplier = Outside offer - Segment margin per unit

= $37 - $10 = $27 per unit.

Financial Advantage = (Cost of manufacturing - relevant cost of buying) x 23,000

= (29 - 27) x 23,000 = $46,000

4. Since there is financial advantage of $46,000, outside supplier offer should be accepted.

Particulars Amount Direct Materials 16 Direct Labor 9 Variable Manufacturing Overhead 4 Fixed manufacturing traceable 0 Fixed Manufacturing allocated 0 Total Relevant Manufacturing cost 29

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