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 $40 per unit. To evaluate this offer, Troy Engines, Ltd., has gathered the following information relating to its own cost of producing the carburetor internally: 18,000 Units Per Unit Per Year $ 18 $ 324,000 Direct materials Direct labor 162,000 36,000 162,000 216,000 Variable manufacturing overhead Fixed manufacturing overhead, traceable Fixed manufacturing overhead, allocated 9* 12 $ 50 $ 900, 000 Total cost *One-third supervisory salaries; two-thirds depreciation of special equipment (no resale value). ERequired: 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 18,000 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 $180,000 per year. Given this new assumption, what would be the financial advantage (disadvantage) of buying 18,000 carburetors E from the outside supplier? 4. Given the new assumption in requirement 3, should the outside supplier's offer be accepted?

Answer 1

Requirement 1

Financial (Disadvantage)

$ (1,44,000.00)

Working

Statement of Cost Analysis(18000 Units)
					Make	Buy	Inremental (cost) or benefit
Purchase Price	$                        -	$     7,20,000.00	$    (7,20,000.00)
Direct Material	$     3,24,000.00	$                        -	$       3,24,000.00
Direct labor	$     1,62,000.00	$                        -	$       1,62,000.00
Variable Manufacturing Overheads	$        36,000.00	$                        -	$          36,000.00
Fixed Manufacturing Overheads,Avoidable	$        54,000.00		$          54,000.00
Total Relevant Cost	$     5,76,000.00	$     7,20,000.00	$    (1,44,000.00)

Requirement 2

No

The offer should be rejected.

Requirement 3

Financial Advantage

$        36,000.00

Working

Statement of Cost Analysis(18000 Units)
					Make	Buy	Inremental (cost) or benefit
Purchase Price	$                        -	$     7,20,000.00	$    (7,20,000.00)
Direct Material	$     3,24,000.00	$                        -	$       3,24,000.00
Direct labor	$     1,62,000.00	$                        -	$       1,62,000.00
Variable Manufacturing Overheads	$        36,000.00	$                        -	$          36,000.00
Fixed Manufacturing Overheads,Avoidable	$        54,000.00		$          54,000.00
Opportunity cost	$     1,80,000.00		$       1,80,000.00
Total Relevant Cost	$     7,56,000.00	$     7,20,000.00	$          36,000.00

Requirement 4

Yes

The offer should be accepted.