Question

Truball Inc., which manufactures sports equipment, consists of several operating divisions. Division A has decided to go outside the company to buy materials since division B plans to increase its selling price for the same materials to $200. Information for division A and division B follows:

Outside price for materials		$125
Division A’s annual purchases		7,500	units
Division B’s variable costs per unit		$115
Division B’s fixed costs, per year	$	1,200,000
Division B’s capacity utilization		100	%

Required:

1. Assume that division B cannot sell its materials to outside buyers. Calculate the net cost or benefit to the company as a whole if Division A purchases the materials outside the company.

2-a. Assume that division B can save $180,000 in fixed costs if it does not manufacture the material for Division A. Calculate the net cost or benefit to the company as a whole for A to purchase outside the company.

2-b. From the standpoint of the effect of the transaction on the company as a whole, should Division A purchase from the outside market?

3-a. Assume the situation in Requirement 1. If the outside market value for the materials drops $15, calculate the net cost or benefit to the company as a whole for A to purchase outside the company.

3-b. From the standpoint of the effect of the transaction on the company as a whole, should Division A purchase from the outside market?

Answer 1

Make or buy decision is based on cost to purchase from outside or manufacturing inside the premises. The division A has decided on buying from outside as division B has hiked the transfer price to $ 200. Whether the overall company would be benefitted in various scenarios is checked out as under:

1.

Purchase Costs from outside ($125*7,500)	$ 937,500
Less: Savings of B's Variable Cost ($115*7,500)	$ 862,500
Net Cost to buy Outside	$ 75,000

2a.

Purchase Costs from outside ($125*7,500)	$ 937,500
Less: Savings of B's Variable Cost ($115*7,500)	$ 862,500
Less: Savings of B Material Assignment	$ 180,000
Net Cost (Benefit) to Buy Outside	($ 105,000)

2b.

Since, the company on whole makes profit when A buys from outside, Division A should definitely purchase from outside. So, the answer is yes.

3a.

Purchase Costs from outside ($125-15)*7,500	$ 825,000
Less: Savings of B's Variable Cost ($115*7,500)	$ 862,500
Net Cost (Benefit) to Buy Outside	($ 37,500)

3b.

Due to the savings in division higher than cost, the company on whole has benefit of $ 37,500.

Hence, Division A should buy from outside. So, the answer is affirmative i.e. yes

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