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 16,000 Units Per per Unit Year $ 16 $ 256,000 12 192,000 3 48,000 3* 48,000 6 96,000 $ 40 $ 640,000 *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 16,000 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 $160,000 per year. Given this new assumption, what would be the financial advantage (disadvantage) of buying 16,000 carburetors from the outside supplier? 4. Given the new assumption in requirement 3, should the outside supplier's offer be accepted?

Answer 1

1-Troy engines Ltd.
	Make	Buy	Differential
Purchase Price		35	115
DM	16		16
DL	12		12
Var. FOH	3		3
Supervisor salary ( 3 * 1/3 )	1		1
Total Relevant cost	32	35	3
Total relevant cost ( 16000 units )	512000	560000	48000
Financial disadvantage of buying is 48000.Offer should not be accepted.
Note :-Supervisor salary is the relevant cost while making the decision while depreciation
of special equipment is irrelevant as it has nothing to do with decision making. It will occur
whether or not the product is made. Allocated Fixed manufacturing OH is also irrelevant
as it will continue to occur irrespective of the carburetor production.
2. No, the outsider's supplier should not be accepted as the same work can be done inhouse
resulting in a cost saving of $ 48000.
3..Total differential cost
	Making	Buying
Cost	512000	560000
Opp. Cost	160000
	672000	560000	112000
Financial advantage of buying is 112000.
4. Troy engines Ltd. Should accept the offer to buy the carburetors @ $ 35 p.u as it will increase the profits
by $ 112,000.