Question

The Dubs division of Fast Company (the parent company) produces wheels for off-road sport vehicles. One-half of Dub's output is sold to the Hoon division of Fast; the remainder is sold to outside customers. Dub's estimated operating profit for the year is shown in the table.

	Internal Sales	External Sales	Totals
Sales	$300,000	$400,000	$700,000
Var Mfg.	$160,000	$160,000	$320,000
Var G&A	$40,000	$60,000	$100,000
CM	$100,000	$180,000	$280,000
Fixed Mfg.	$24,000	$32,000	$56,000
Fixed G&A	$36,000	$48,000	$84,000
Op. Profits	$40,000	$100,000	$140,000
Unit Sales	1,000	1,000	2,000

Unless otherwise stated assume the fixed costs given above are allocated costs and unavoidable. Hoon division has an opportunity to purchase 1,000 wheels of the same quality from an outside supplier on a continuing basis for $250.00 per wheel.

To simplify this example, assume the capacity of the Dubs division is 2,000 units and it is producing and selling units as shown in the table.

• The managers of Dubs believe it could sell an additional 500 units at the current price into the external market.
• The senior management of Fast company requires Dubs to provide the Hoon division with 1,000 units at the current internal price.
• Dubs managers believe that an additional 500 units of capacity could be acquired by expanding their current facilities and investing in several new machines. They expect this would increase the total fixed manufacturing costs of Dubs by $60,000 per year.

By how much would Dubs’ total operating profit change if this investment were undertaken? Indicate an increase with a positive number and a decrease with a negative number, e.g. -10000.

1. To simplify this example, assume the capacity of the Dubs division is 2,000 units and it is producing and selling units as shown in the table. If Dubs could sell all of its units in the external market at the current external selling price, by how much would Fast’s total contribution margin increase? Now also assume the Hoon division’s external supplier has raised its price to $325.00 per wheel. Indicate an increase with a positive number and a decrease with a negative number, e.g. -10000.

2. What would be the increase in Hoon division’s total operating profits if Fast Company allows the Hoon division to purchase the wheels it needs from the outside supplier?

3. By how much would Dubs’ total operating profit change if this investment were undertaken? Indicate an increase with a positive number and a decrease with a negative number, e.g. -10000.

Answer 1

If Dubs could sell all of its units in the external market at the current external selling price, by how much would Fast’s total contribution margin increase?

external selling price per unit = sales/unit sales

=400000/1000

= 400

			external sales
	sales	$ 400X2000	$800,000
	var mfg	Total Actual	$ 320,000
	var g& a	Total Actual	$ 100,000
	CM		$ 380,000
	fixed mfg	Total Actual	$ 56,000
	fixed g & a	Total Actual	$ 84,000
	Op. Profit		$ 240,000
	Unit Sales		2000

Contribution margin of dubs = $380,000

hoons division purchase = $325x1000

= $325,000

hoons profit if its purchases from external supplier = $400x1000-$325000

=$75000

2. What would be the increase in Hoon division’s total operating profits if Fast Company allows the Hoon division to purchase the wheels it needs from the outside supplier?

sales = $ 400 X 1000 = $400,000

purchase from external supplier = $250 X 1000=250,000

operating profit = sales - purchase

= $400,000-$250,000

= $1,50,000

3 By how much would Dubs’ total operating profit change if this investment were undertaken?

	internal	external	total
sales	$300,000	$600,000	$900,000
var mfg	$160,000	$160,000	$320,000
var g& a	$40,000	$60,000	$100,000
CM	$100,000	$380,000	$480,000
fixed mfg	$24,000	$32,000	$11,6000 *
fixed g & a	$36,000	$48,000	$84,000
Op. Profit	$40,000	$300,000	$280,000
Unit Sales	1000	1500	2500

additional fixed manufacturing cost 60000

addition units 500 external sales

existing operating profit - profit after investment

$140,000-$280,000=$ 140,000 increase in profit