## Wednesday, 1 April 2015

### 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.

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 \$21 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 15,800 Units Per Year Direct materials \$ 5 \$ 79,000 Direct labor 7 110,600 Variable manufacturing overhead 4 63,200 Fixed manufacturing overhead, traceable 6* 94,800 Fixed manufacturing overhead, allocated 9 142,200 Total cost \$ 31 \$ 489,800
 *40% supervisory salaries; 60% depreciation of special equipment (no resale value).

 Required:
1a.
Assuming that the company has no alternative use for the facilities that are now being used to produce the carburetors, compute the total cost of making and buying the parts.

 1b. Should the outside supplier’s offer be accepted? Reject

 2a. 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 \$46,080 per year. Compute the total cost of making and buying the parts.

Exercise 12-3 Make or Buy a Component [LO12-3]
 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 \$21 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 15,800 Units Per Year Direct materials \$ 5 \$ 79,000 Direct labor 7 110,600 Variable manufacturing overhead 4 63,200 Fixed manufacturing overhead, traceable 6* 94,800 Fixed manufacturing overhead, allocated 9 142,200 Total cost \$ 31 \$ 489,800
 *40% supervisory salaries; 60% depreciation of special equipment (no resale value).

 Required:
 1a. Assuming that the company has no alternative use for the facilities that are now being used to produce the carburetors, compute the total cost of making and buying the parts. (Round your Fixed manufacturing overhead per unit rate to 2 decimals.)

 1b. Should the outside supplier’s offer be accepted? Reject

 2a. 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 \$46,080 per year. Compute the total cost of making and buying the parts. (Round your Fixed manufacturing overhead per unit rate to 2 decimals.)

 2b. Should Troy Engines, Ltd., accept the offer to buy the carburetors for \$21 per unit? Accept

Explanation:1.
 Per Unit Differential Costs 15,800 Units Make Buy Make Buy Cost of purchasing \$ 21 \$ 331,800 Direct materials \$ 5 \$ 79,000 Direct labor 7 110,600 Variable manufacturing overhead 4 63,200 Fixed manufacturing overhead, traceable1 2.40 37,920 Fixed manufacturing overhead, common - - - Total costs \$ 18.40 \$ 21 \$ 290,720 \$ 331,800 Difference in favor of continuing to make the carburetors \$2.60 \$41,080

 1Only the supervisory salaries can be avoided if the carburetors are purchased. The remaining book value of the special equipment is a sunk cost hence, the \$4 per unit depreciation expense is not relevant to this decision. Based on these data, the company should reject the offer and should continue to produce the carburetors internally.

2a.

 Make Buy Cost of purchasing (part 1) \$ 331,800 Cost of making (part 1) \$ 290,720 Opportunity cost—segment margin forgone on a potential new product line 46,080 Total cost \$ 336,800 \$ 331,800 Difference in favor of purchasing from the outside supplier \$5,000

2b.
Thus, the company should accept the offer and purchase the carburetors from the outside supplier.