Question

InterGlobal Industries is a diversified corporation with separate operating divisions. Each division’s performance is evaluated on the basis of profit and return on investment.

The Air Comfort Division manufactures and sells air-conditioner units. The coming year’s budgeted income statement, which follows, is based upon a sales volume of 20,000 units.

AIR COMFORT DIVISION
Budgeted Income Statement
(In thousands)
	Per Unit					Total
Sales revenue		$	408				$	8,160
Manufacturing costs:
Compressor		$	77				$	1,540
Other direct material			37					740
Direct labor			31					620
Variable overhead			30					600
Fixed overhead			29					580
Total manufacturing costs		$	204				$	4,080
Gross margin		$	204				$	4,080
Operating expenses:
Variable selling		$	20				$	400
Fixed selling			20					400
Fixed administrative			37					740
Total operating expenses		$	77				$	1,540
Net income before taxes		$	127				$	2,540

Air Comfort’s division manager believes sales can be increased if the price of the air-conditioners is reduced. A market research study by an independent firm indicates that a 4 percent reduction in the selling price would increase sales volume 21 percent, or 4,200 units. The division has sufficient production capacity to manage this increased volume with no increase in fixed costs.

The Air Comfort Division uses a compressor in its units, which it purchases from an outside supplier at a cost of $77 per compressor. The Air Comfort Division manager has asked the manager of the Compressor Division about selling compressor units to Air Comfort. The Compressor Division currently manufactures and sells a unit to outside firms that is similar to the unit used by the Air Comfort Division. The specifications of the Air Comfort Division compressor are slightly different, which would reduce the Compressor Division’s direct material cost by $3.20 per unit. In addition, the Compressor Division would not incur any variable selling costs in the units sold to the Air Comfort Division. The manager of the Air Comfort Division wants all of the compressors it uses to come from one supplier and has offered to pay $48 for each compressor unit.

The Compressor Division has the capacity to produce 75,000 units. Its budgeted income statement for the coming year, which follows, is based on a sales volume of 64,000 units without considering Air Comfort’s proposal.

COMPRESSOR DIVISION
Budgeted Income Statement
(In thousands)
	Per Unit					Total
Sales revenue		$	92				$	5,888
Manufacturing costs:
Direct material		$	12				$	768
Direct labor			8					512
Variable overhead			10					640
Fixed overhead			13					832
Total manufacturing costs		$	43				$	2,752
Gross margin		$	49				$	3,136
Operating expenses:
Variable selling		$	6				$	384
Fixed selling			4					256
Fixed administrative			7					448
Total operating expenses		$	17				$	1,088
Net income before taxes		$	32				$	2,048

Required:
1. Calculate the increase/decrease in net income before taxes for Continental Industries assuming the Air Comfort Division institutes the 4 percent price reduction on its air-conditioner units even if it cannot acquire the compressors internally for $48 each.

	Increase in net income before taxes of

2. Independently of your answer to Required 1-a, assume the Air Comfort Division needs 24,200 units. Calculate the increase/decrease in net income before taxes for the Compressor Division if it supplies the 24,200 compressor units for $48 each.

	Decrease in net income before taxes of

3. Independently of your answer to Required 1-a, assume the Air Comfort Division needs 24,200 units. Calculate the increase/decrease in net income before taxes for Continental Industries if the Compressor Division supplies the 24,200 compressor units for $48 each.

	Increase in net income before taxes of    $

Answer 1

Required:
1. Calculate the increase/decrease in net income before taxes for Continental Industries assuming the Air Comfort Division institutes the 4 percent price reduction on its air-conditioner units even if it cannot acquire the compressors internally for $48 each.
AIR COMFORT DIVISION
Budgeted Income Statement
(In thousands)	Before Price Reduction in 4%		After Price Reduction in 4%
	Per Unit	Total	Per Unit	Total
Units	20	thousands	24.2	thousands
Sales revenue	$                            408.00	$            8,160.00	$        391.68	$                                    9,478.66
Manufacturing costs:
Compressor	$                              77.00	$            1,540.00	$          77.00	$                                    1,863.40
Other direct material	$                              37.00	$               740.00	$          37.00	$                                       895.40
Direct labor	$                              31.00	$               620.00	$          31.00	$                                       750.20
Variable overhead	$                              30.00	$               600.00	$          30.00	$                                       726.00
Variable selling	$                              20.00	$               400.00	$          20.00	$                                       484.00
Total variable  costs	$                            195.00	$            3,900.00	$        195.00	$                                    4,719.00
Contribution margin	$                            213.00	$            4,260.00	$        196.68	$                                    4,759.66
Increase in net income before tax	$                  4,759,656.00
2. Independently of your answer to Required 1-a, assume the Air Comfort Division needs 24,200 units. Calculate the increase/decrease in net income before taxes for the Compressor Division if it supplies the 24,200 compressor units for $48 each.
	Outside Sales	Air Comfort Sales
	Per Unit	Per unit
Sales revenue	$                              92.00	$                 48.00		Capacity calculation in units:
Manufacturing costs:				Total capacity	75000
Direct material	$                              12.00	$                   8.80		Sales to Air Comfort	24200
Direct labor	$                                8.00	$                   8.00		Balance	50800
Variable overhead	$                              10.00	$                 10.00		Projected sales to outsiders	64000
Variable selling	$                                6.00	$                       -		Lost sales to outsiders .	13200
Total variable costs	$                              36.00	$                 26.80
Contribution  margin	$                              56.00	$                 21.20
Contribution from sales to Air Comfort ($21.20 x 24,200 units)	$                     513,040.00
Loss in contribution from loss of sales to outsiders ($56  x 13,200 units)	$                     739,200.00
Decrease in net income before taxes	$                     226,160.00
Decrease	in net income before taxes of	$        226,160.00
3. Independently of your answer to Required 1-a, assume the Air Comfort Division needs 24,200 units. Calculate the increase/decrease in net income before taxes for Continental Industries if the Compressor Division supplies the 24,200 compressor units for $48 each.
Cost savings by using compressor unit from Compressor Division:
Compressor Division:
Outside purchase price	$                              77.00
Compressor Divisions variable cost to produce	$                              26.80
Savings per unit.	$                              50.20
x Number of units	24200
Total cost savings	$                  1,214,840.00
Compressor Divisions loss in contribution from loss of sales to outsiders	$                     739,200.00
Increase in net income before taxes for InterGlobal Industries	$                     475,640.00
Increase	in net income before taxes of	$        475,640.00