Question

Stavos Company’s Screen Division manufactures a standard screen for high-definition televisions (HDTVs). The cost per screen follows:

Variable cost per screen	$	118
Fixed cost per screen		28	*
Total cost per screen	$	146

*Based on a capacity of 780,000 screens per year.

Part of the Screen Division’s output is sold to outside manufacturers of HDTVs and part is sold to Stavos Company’s Quark Division, which produces an HDTV under its own name. The Screen Division charges $182 per screen for all sales.

The costs, revenue, and net operating income associated with the Quark Division’s HDTV are given below:

Selling price per unit			$	585
Variable cost per unit:
Cost of the screen	$	182
Variable cost of electronic parts		233
Total variable cost				415
Contribution margin				170
Fixed costs per unit				86	*
Net operating income per unit			$	84

*Based on a capacity of 190,000 units per year.

The Quark Division has an order from an overseas source for 5,000 HDTVs. The overseas source wants to pay only $392 per unit.

Required:

1. Assume the Quark Division has enough idle capacity to fill the 5,000-unit order. Is the division likely to accept the $392 price or to reject it?

2. Assume both the Screen Division and the Quark Division have idle capacity. Under these conditions, what is the financial advantage (disadvantage) for the company as a whole (on a per unit basis) if the Quark Division rejects the $392 price?

3. Assume the Quark Division has idle capacity but that the Screen Division is operating at capacity and could sell all of its screens to outside manufacturers. Under these conditions, what is the financial advantage (disadvantage) for the company as a whole (on a per unit basis) if the Quark Division accepts the $392 unit price.

Answer 1

1. If Quark Division has enough idle capacity to fill the 5,000-unit order, the minimum price that it would charge will be the variable cost of producing the HDTVs.

The fixed cost would be irrelevant for decision-making since the same have to be incurred whether or not the 5,000-unit order is fulfilled.

Accordingly, the minimum price it would charge will be $415 ($182+$233). Hence, the Quark Division is likely to reject the order.

2. Assuming both the Screen Division and Quark Division have idle capacity, Screen Division would be willing to provide the screens to Quark Division at it's variable cost $118.

Accordingly, Quark Division will be willing to charge a minimum of $351 ($118 for screen + $233 for electronic parts)

So, if Quark Division rejects the price of $392, it would lead to a financial disadvantage for the company.

The amount of financial disadvantage is calculated below:

Minimum price Quard Division can charge for 5,000 units @ $351 = $1,755,000

Revenue rejected by Quark Division for 5,000 units @ $392 = $1,960,000

Amount of financial disadvantage ($1,960,000 - $1,755,000) = $205,000

3. Assuming the Quark Division has idle capacity but that the Screen Division is operating at capacity and could sell all of its screens to outside manufacturers, Screen Division would charge the normal selling price of $182 it charges to outside customers from Quark Division since it does not have any idle capacity.

Now, the total variable cost per unit for Quark Division would be $415.

If Quark Division accepts the $392 unit price, it would lead to a financial disadvantage to the company as computed below:

Revenue resulting from the sale of 5,000 units @ $392 = $1,960,000

Variable cost to Quark Division for 5,000 units @ $415 = $2,075,000

Amount of financial disadvantage ($2,075,000 - $1,960,000) = $115,000