Question

Blue Co has two divisions, A and B. Division A makes a component for air conditioning units which it can only sell to Division B. It has no other outlet for sales.

Current information relating to Division A is as follows:

Marginal cost per unit	€100
Transfer price of the component	€165
Total production and sales of the component each year	2,200 units
Specific fixed costs of Division A per year	€10,000

Green Co has offered to sell the component to Division B for €140 per unit.

If Division B accepts this offer, Division A will be closed. If Division B accepts Green Co’s offer, what will be the impact on profits per year for the group as a whole?

Answer 1

Answer)

Calculation of impact on the Net profits of the compnay

Particulars	Amount (In $)
Savings in Component cost to Division B [$ 2,200 units X ($ 165 - $ 140)]	55,000
Loss on account of closure of Department A	133,000
Change in Profits of the company	(78,000)

Therefore if the Division B procures the component from outside supplier and division A is closed down, the Net profit of the company will fall by $ 78,000.

Working Note:

Calculation of Net Operating income of Division A

Particulars	Per unit (In $)	Total (In $)
Tranfer Price (2,200 units X $ 165 per unit)	165	363,000
Less: Marginal Cost(2,200 units X $ 100 per unit)	100	220,000
Contribution Margin	65	143,000
Fixed cost of Department A		10,000
Net Operating Income		133,000