Question

Troy Engines, Ltd., manufactures a variety of parts for use in its product. The company has always produced all of the necessary parts for its product, including all of the electronic circuits. The company sells 22,000 units of its product per year. An outside supplier has offered to sell electronic circuits to the company for a cost of $35 per unit. To evaluate this offer, the company has gathered the following information relating to its own cost of producing the electronic circuits internally:

Per Unit 14,000 unit per per year
Direct materials $14 $196,000
Direct labor 10 140,000
Variable manufacturing overhead 4 56,000
Fixed manufacturing overhead, traceable 6 84,000
Fixed manufacturing overhead, allocated 9 126,000
Total cost $43 $602,000

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 14,000 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 $140,000 per year. Given this new assumption, what would be financial advantage (disadvantage) of buying 14,000 carburetors from the outside supplier?
d. Given the new assumption in requirement 3, should the outside supplier's offer be accepted?

Answer 1

Answer and Explanation:

The computation is shown below:

a.

Differential analysis

Particulars Make Buy

Direct material 196000

Direct labour 140000

variable manufacturing

overhead 56000

Fixed manufacturing

overhead (84000 ÷ 3) 28000

Purchase cost (14000 × 35) 490000

Total relevant cost $420,000 $490,000

Financial (disadvantage) is -$70,000

b. No as there is a financial disadvantage

c.

Differential analysis

Particulars Make Buy

Direct material 196000

Direct labour 140000

variable manufacturing

overhead 56000

Fixed manufacturing

overhead (84000 ÷ 3) 28000

Opportunity cost $140,000

Purchase cost (14000 × 35) 490000

Total relevant cost $560,000 $490,000

Financial advantage is $70,000

d. Yes it should be accepted as it is a financial advantage