Optimizing Production Costs: Should Troy Engines, Ltd. Accept the Outside Supplier's Offer?
Should Troy Engines, Ltd. consider buying electronic circuits from an outside supplier?
a. What would be the financial advantage or disadvantage of buying 14,000 carburetors from the outside supplier?
b. Should the outside supplier's offer be accepted?
c. What would be the financial advantage or disadvantage of buying 14,000 carburetors if the freed capacity is used to launch a new product?
d. Should the outside supplier's offer be accepted considering the new assumption?
Answer and Explanation:
a. The financial advantage or disadvantage of buying 14,000 carburetors from the outside supplier can be determined through a differential analysis:
Make: Total relevant cost = $420,000; Buy: Total relevant cost = $490,000; Financial (disadvantage) is -$70,000.
b. No, the outside supplier's offer should not be accepted as there is a financial disadvantage.
c. Considering the opportunity cost of $140,000 for launching a new product with the freed capacity, the financial advantage of buying 14,000 carburetors from the outside supplier would be $70,000.
d. Yes, the outside supplier's offer should be accepted in this scenario as it results in a financial advantage.
In evaluating whether Troy Engines, Ltd. should accept the outside supplier's offer to purchase electronic circuits, several factors need to be considered. The company currently produces all necessary parts for its product internally, including electronic circuits. However, an outside supplier has proposed selling electronic circuits at a cost of $35 per unit.
By conducting a differential analysis, the company can compare the total relevant costs of producing the electronic circuits internally versus buying them from the outside supplier. In the initial scenario where there is no alternative use for the existing facilities, the company faces a financial disadvantage of $70,000 if they choose to buy 14,000 carburetors from the outside supplier.
However, if the freed capacity from purchasing the carburetors can be utilized to launch a new product with a segment margin of $140,000 per year, the financial advantage of buying from the outside supplier increases to $70,000. In this case, accepting the outside supplier's offer would be beneficial financially.
Ultimately, the decision to accept the outside supplier's offer should be based on the company's long-term strategic goals, potential for utilizing freed capacity, and overall financial impact. By carefully analyzing the costs and benefits, Troy Engines, Ltd. can make an informed decision to optimize its production costs and potentially drive new product innovation.