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		$120
Division A’s annual purchases		7,000	units
Division B’s variable costs per unit		$110
Division B’s fixed costs, per year	$	1,190,000
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 $185,000 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 $17, 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

Solution 1:
Computation of Net cost or benefit to the company
Savings of Division B's Variable Cost ($110*7000)	770000
Less: Purchase Costs from outside ($120*7000)	840000
Net Cost to buy Outside	-70000
Solution 2a:
Computation of Net cost or benefit to the company
Savings of Division B's Variable Cost ($110*7000)	770000
Savings of Division B's Fixed Cost	185000
Less: Purchase Costs from outside ($120*7000)	840000
Net Benefit to buy Outside	115000

Solution 2b:

Yes, Division A should purchase from the outside market

Solution 3a:

Computation of Net cost or benefit to the company
Savings of Division B's Variable Cost ($110*7000)	770000
Less: Purchase Costs from outside [($120 - $17)*7000]	721000
Net Benefit to buy Outside	49000

Solution 3b:

Yes, Division A should purchase from the outside market.