Question

Assume that Division A has has a product that can be sold either to Division B of the same company or to outside customers. The manager of both division are evaluated based on their own divisions return on investment. The manager are free to decide if they will participate in any internal transfers.

Division A

Capacity in units = 300,000

Number of units now being sold out to outside customers = 300,000

Selling price per unit on the outside market = $41

Variable costs per unit = $19

Fixed costs per unit = $12

Division B

# of units needed annually = 10,000

Purchase price now being paid to outside supplier = $38

Division A can avoid $6 per unit in variable costs on any sales to Division B. Assume Division A offers to sell 100,000 units to Division B for $36 per unit and that Division B refuses this price. What will be the impact on company profit compared to the profit if the offer was accepted?

+$200,000

+$100,000

+$300,000

-$300,000

-$200,000

Answer 1

Case 1) If offer is not accepted :

Division A

Variable cost= $19

Fixed cost = $12

Total cost = $19+ $12 i.e. $31

Selling price= $41

Profit= $41- $31 i.e. $10 per unit

Profit if product sold to outsider by Division A for 100000 Units

$10 X 1,00,000 units

i.e. $10,00,000

Division B

Purchase price per unit from outside = $38

Cost for 1,00,000 unit = $38 X 1,00,000 units

Cost for 1,00,000 unit = $38,00,000

Case 2) If offer is accepted by Division B

Division A:

Sale price= $36

Saving in variable cost of $6 i.e. New variable cost = $19- $6 = $13

Fixed cost = $12

Total cost = $13+ $12 i.e. $25

Profit = $36- $25 i.e. $11 per unit

Profit if product sold to Division B by Division A for 100000 Units

$11 X 1,00,000 units = $11,00,000

Division B

Purchase price per unit = $36

Cost for 100000 unit = $36 X 1,00,000 units

Cost for 100000 unit = $36,00,000

Analysis:

Extra profit of $1,00,000 ($11,00,000 - $10,00,000) will be earn by Division A if units sold to Division B (not to outsider)
Extra saving of $2,00,000 ($38,00,000 - $36,00,000) will be done by Division B if it take units from Division A (not from outside)
Total saving if offer is accepted = $1,00,000+ $2,00,000= $3,00,000

As the offer is rejected by Division B therefore there is loss of $ 3,00,000

Answer is -$300000