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 $36 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 20,000 Units Per Year
Direct materials $17 $340,000
Direct labor 10 200,000
Variable manufacturing overhead 2 40,000
Fixed manufacturing overhead, traceable 9 180,000
Fixed manufacturing overhead, allocated 12 240,000
Total cost $50 604,000

Required:

a. 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 17,000 carburetors from the outside supplier?
b. Should the outside supplier’s offer be accepted?
c. 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 $170,000 per year. Given this new assumption, what would be financial advantage (disadvantage) of buying 17,000 carburetors from the outside supplier?
d. Given the new assumption in requirement 3, should the outside supplier’s offer be accepted?

Troy Engines, Ltd.

a. The financial advantage of buying from the outside supplier = $34,000

b. The outside supplier's offer should be accepted.

c. The financial disadvantage of buying from the outside supplier = $136,000.

d. The outside supplier's offer should not be accepted.

Explanation:

a) Data and Calculations:

Cost of                                                                   Internal                External

                                                                        Production        Procurement

Per Unit 20,000 Units Per Year                  

Direct materials                                          $17 $340,000

Direct labor                                                   10   200,000

Variable manufacturing overhead               2      40,000    $36   $720,000

Fixed manufacturing overhead, traceable  9    180,000

Fixed manufacturing overhead, allocated 12    240,000               240,000

Total cost                                                  $50   604,000             $960,000

a) Buying 17,000 carburetors:

Cost of                                                                   Internal                External

                                                                        Production        Procurement

Variable manufacturing cost                       29  493,000    $36    $612,000

Fixed manufacturing overhead, traceable  9    153,000

Fixed manufacturing overhead, allocated 12   240,000                240,000

Total cost                                                  $50 $886,000             $852,000

The financial advantage of buying from the outside supplier = $34,000 ($886,000 - $852,000)

b) The segment margin of the new product launched:

a) Buying 17,000 carburetors:

Cost of                                                                   Internal                External

                                                                        Production        Procurement

Variable manufacturing cost                       29  493,000    $36    $612,000

Fixed manufacturing overhead, traceable  9    153,000

Fixed manufacturing overhead, allocated 12   240,000                240,000

Total cost                                                  $50 $886,000             $852,000

New segment product's margin                       (170,000)

Net total cost                                                    $716,000              $852,000

The financial disadvantage of buying from the outside supplier = $136,000 ($716,000 - $852,000).