Problem A Frances Industries has two divisions (Parts and Tools).The Tools Divis

Question

Problem A Frances Industries has two divisions (Parts and Tools).The Tools Division wants to purchase a part from the Parts Division to use in manufacturing a new product. Information about the requested part: Parts Division Capacity (per year) $ 200,000 Sales price to outside parties $ 100.00 Variable cost/part 40.00 Fixed cost/year 10,000,000 1. The Parts Division is currently manufacturing 100,000 parts per year. Tools Division asks for 20,000 parts. What is the minimum price (per unit) the Parts Division should charge? 2. Assume instead that the Parts Division is currently operating at full capacity (all units are sold to outside customers) and capacity can't be increased. 3. Assume instead that the Parts Division is currently selling 190,000 parts to outside customers? What is the minimum price (per unit) the Parts Division should charge? 4.What is the minimum price (per unit) the Parts Division should charge?

Explanation / Answer

Capacity 200000 units Currently manufacturing at 100000units at 200000 units 1900000 Sale price to outsider 100 10000000 20000000 19000000 Variable Cost 40 4000000 8000000 7600000 Contribution per unit 60 6000000 12000000 11400000 Fixed Cost 10000000 10000000 10000000 10000000 Net operating Income -4000000 2000000 1400000 1) If the parts division is operating at 100000 units capacity and selling 100000 units , it has spare capacity of 100000 units which is lying idle and the fixed cost has already been incurred Hence, It should charge a minimum of $ 40 which will cover its variable cost ,also it’s a division in the same company. hence the division when thecapacity is lying idle should noy try to make contribution 2) If the plant is manufacturing and selling at full capacity , then the minimum price to be charged should be $ 100, which is the price charged fromoutsiders , because ifanything less than 100 is charged , this will reduce the contribution and net operating income of the division 3) If the division is manufacturing and selling to outsiders 190000 units , then the situation has to be looked at from 2 pointa As the Tools division needs 20000 units - The parts division will have to give up 10000 units sales to outsiders Hence the revenue loss for 10000 units is $ 100 per unit For thebalnce 10000 the capacity is idle and theminimum price that the division should charge is $ 40 as per (1) above Hence the price should be an average of the two = (100+ 40)/2 = $ 70 By charging $ 70 , the tools division current profitability will remain intact and the idlecapacity will also be utilised and the variable expenses will get covered 4) The minimum price per unit that Parts division should charge under Scenario 1 $40 Scenario 2 $100 Scenario 3 $70

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