Question

Division S of Goody Company makes a part with the following characteristics: Production capacity Selling price on the outside market Variable costs per unit Fixed costs per unit 50,000 units $20 $12 $3 Division B, another division in the same company, presently is purchasing 10,000 units of a similar part each period from an outside supplier, but would like to start purchasing from Division S. Division B is now paying a price of $18 per unit to the outside supplier. 1. Suppose that Division S has ample idle capacity to handle all of Division B's needs without any increase in fixed costs and without cutting into sales to outsiders. If Division S refuses to accept the $18 price from Division B, what would be overall impact on the company’s profit as a whole? Use plus “+” or minus “-“ to denote the impact. 2. Suppose that Division S can sell all that it can produce to outside customers at its regular selling price. If Division S sells to Division B at a price of $18 per unit, what would be impact on company’s profit as a whole? Use plus “+” or minus “-“ to denote the impact.

Answer 1

1. If Division S refuses to accept the $18 price from Division B, the following would be the overall impact on the company's profit as a whole: - 60,000

As Division S has ample idle capacity for Division B's needs, without any increase in fixed costs, it can supply the part to Division B without considering the fixed cost of $3 per unit. The fixed costs are not relevant. Hence the company as a whole is losing out on $ 6 per unit (Transfer Price $18 - Variable Cost $12) for 10,000 units due to Division B relying on an outisde purchaser.

Even if Division S supplies for $18 per part, it will make a profit of $18 - $12 = $6 x 10,000 = $60,000, as fixed costs are not relevant.

2. If Division S sells to Division B at a price of $18 per unit, the following would be the impact on company’s profit as a whole: - $20,000

Unlike the first case, there is no ample capacity here, so if Division S is selling to Division B for $18 per unit, it is also losing out on equal outside sales of $20 per unit. Hence if it supplies 10,000 units to Division B, it is losing out on Profits of : Outside selling price $20 - Transfer price $18 = $2 x 10,000 units = $20,000. In this case, it is better for the company as a whole, if Division B purchases the part from the outside market for $18 and not depend on Division S.