Question

Sembotix Company has several divisions including a Semiconductor Division that sells semiconductors to both internal and external customers. The company’s X-ray Division uses semiconductors as a component in its final product and is evaluating whether to purchase them from the Semiconductor Division or from an external supplier. The market price for semiconductors is $100 per 100 semiconductors. Dave Bryant is the controller of the X-ray Division, and Howard Hillman is the controller of the Semiconductor Division. The following conversation took place between Dave and Howard:

Dave: I hear you are having problems selling semiconductors out of your division. Maybe I can help.

Howard: You’ve got that right. We’re producing and selling at about 90% of our capacity to outsiders. Last year, we were selling 100% of capacity. Would it be possible for your division to pick up some of our excess capacity? After all, we are part of the same company.

Dave: What kind of price could you give me?

Howard: Well, you know as well as I that we are under strict profit responsibility in our divisions, so I would expect to get market price, $100 for 100 semiconductors.

Dave: I’m not so sure we can swing that. I was expecting a price break from a “sister” division.

Howard: Hey, I can only take this “sister” stuff so far. If I give you a price break, our profits will fall from last year’s levels. I don’t think I could explain that. I’m sorry, but I must remain firm— market price. After all, it’s only fair—that’s what you would have to pay from an external supplier.

Dave: Fair or not, I think we’ll pass. Sorry we couldn’t have helped.

Is Dave behaving unethically by trying to force the Semiconductor Division into a price break? Comment on Howard’s reactions.

Answer 1

ANSWER

now to understand the mechanics of cost and profit, we first need to understand two different types of cost, i.e

1) FIXED COST and 2) VARIABLE COST

Fixed costs are the costs that remain the same for a company irrespective of the level of production, i.e, even if the company is not producing anything, it has to bear the fixed costs,

on the other hand variable cost is the cost that has to be incurred for each additional level of units produced,

in this case the semiconductor division is producing at 90% capacity since they can increase their production level to 100 percent capacity and generate additional revenue, they have to incur only the variable cost for additional 10% increase in production, so for the semiconductor division as long as they are receiving more than the variable cost for the sales of their additional 10 % production , they should go for it,

for instance say variable cost is $60 per unit, for the semiconductor division, then Howard shall manufacture and sell the additional 10% production as long as he can fetch more than $60 per unit of semiconductor, hence it is not justifiable from Howard's end to reject the proposal from dave

on the other hand from dave's perspective it can be observed that the X-RAY division is already getting the semiconductors from the market @ $100 per unit , so it only makes sense to purchase them from semiconductor division if dave is able to obtain them from a price less than $100 per unit, so it is not unethical from dave's end to ask for a price break as long as he is ready to pay Howard more than the variable cost per unit of the semi conductor division.

NOTE- IT IS ASSUMED THAT EACH DIVISION IS ACTING AS A SEPERATE PROFIT CENTRES