Question

A firm has two departments: Seller and Buyer. Department Seller provides a critical component for Department Buyer’s final product. Department Buyer can purchase the part on the external market for $100.

Department Seller has insufficientcapacity: Department Buyer needs 500 units and Department Seller only has excess capacity for 200 units. The following cost and price data apply to Department Seller.

                  External Market price                                                                            $108

                  Variable selling/distribution costs on external sales10

                  Variable manufacturing cost                                                                   40

                  Fixed manufacturing cost (per unit) 25

What is the minimum price that would be negotiated between these departments (rounded to nearest dollar if necessary)?

Answer 1

When no excess or part of capacity existing in selling deptt, then the selling deptt must charge
the variable cost of manuacture the units and loss of contribution of normal sales.
Contribution margin per unit from external sales:
Selling price				108
Less: variable cost
Manufacturing cost				40
Selling admin cost				10
Contribution margin per unit from external sales:				58
Loss of external sales:
Total units to be transferred to buying deptt				500
Less: Spare capacity existed				200
Loss of external sales:				300
Loss of contribution from external sales = 300 units @58 =					17,400
Manufacturing cost variable for 500 units = 500*40 =					20,000
Total amount required from buying deptt					37,400
Divide: Number of units					500
Minimum price to be taken by Selling deptt					74.8
Answer is $74.80