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:

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:

	Per Unit				21,000 Units Per Year
Direct materials	$	14		$	294,000
Direct labor		12			252,000
Variable manufacturing overhead		2			42,000
Fixed manufacturing overhead, traceable		9	*		189,000
Fixed manufacturing overhead, allocated		12			252,000
Total cost	$	49		$	1,029,000

*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 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 the financial advantage (disadvantage) of buying 21,000 carburetors from the outside supplier?

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

Explanation

1.

		Per Unit Differential Costs				21,000 Units
		Make		Buy		Make		Buy
Cost of purchasing			$	34			$	714,000
Direct materials	$	14			$	294,000
Direct labor		12				252,000
Variable manufacturing overhead		2				42,000
Fixed manufacturing overhead, traceable1		3				63,000
Fixed manufacturing overhead, common		-				-		-
Total costs	$	31	$	34	$	651,000	$	714,000
Financial (disadvantage) of buying the carburetors	$ (3)				$ (63,000)

¹Only the supervisory salaries of $3 per unit (= $9 per unit × 1/3) can be avoided if the carburetors are purchased. The remaining book value of the special equipment is a sunk cost; hence, the $6 per unit depreciation expense (= $9 × 2/3) per unit is not relevant to this decision.

2. Based on these data, the company should reject the offer and should continue to produce the carburetors internally.

3.

		Make		Buy
Cost of purchasing (see requirement 1)			$	714,000
Cost of making (see requirement 1)	$	651,000
Opportunity cost—segment margin foregone on a potential new product line		210,000
Total cost	$	861,000	$	714,000
Financial advantage of buying the carburetors		$ 147,000

4. Given the new assumption, the company should accept the offer and purchase the carburetors from the outside supplier.

Thanks