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: Per Unit 15,000 Units Per Year Direct materials $ 14 $ 210,000 Direct labor 10 150,000 Variable manufacturing overhead 3 45,000 Fixed manufacturing overhead, traceable 6 .90,000 Fixed manufacturing overhead, allocated 9 135,000 Total cost $ 42 $ 630,000. One-third supervisory salaries; two-thirds depreciation of special equipment (no resale value).

Required:
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 15,000 carburetors from the outside supplier?

Answer 1

Buying carburetors from an outside supplier would result in a financial disadvantage of $120,000 compared to the cost of producing them internally at Troy Engines, Ltd.

Step-by-step explanation:

The question revolves around cost-benefit analysis for Troy Engines, Ltd., to decide whether to buy carburetors from an outside supplier or continue producing them internally. Only the variable costs and the traceable fixed costs that would be eliminated if production is stopped should be considered in making this decision. The allocated fixed costs are sunk and will remain regardless of the decision.

Here's the breakdown of costs if Troy Engines continues to produce carburetors internally:

Direct materials: $210,000Direct labor: $150,000Variable manufacturing overhead: $45,000Fixed manufacturing overhead, traceable: $90,000

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If these carburetors are bought externally, the company will avoid the direct materials, direct labor, and variable overhead costs, making a total of $405,000.

The offer from the external supplier is $35 per unit for 15,000 units, totaling $525,000.

The financial advantage or disadvantage is calculated as:

Internal production costs avoided - External purchase costs = $405,000 - $525,000 = (-$120,000)

Therefore, buying from the supplier would be a financial disadvantage of $120,000 for Troy Engines, Ltd.