R Enterprises has just opened a new division (B). One of their other divisions (
ID: 2467993 • Letter: R
Question
R Enterprises has just opened a new division (B). One of their other divisions (A) makes a part that could be used in one of Division B's products.
Use the following informattion:
New Division--Division B:
Quantity needed 40,000 parts per year
Price from outside supplier $48 per part
Division A:
Production Capacty 100,000 parts per year
Currently selling 80,000 parts per year
Selling price $60 per part
Variable costs: Manufacturing $30 per part, Selling $2 per part; Fixed costs $3,000,000 per year
R Enterprises is unwilling to increase capacity. All variable selling costs would be avoided on an intracompany transfer.
1. What's the maximum amount Division B would be willing to pay Division A?
2. What's the minimum amount Division A would be willing to charge Division B?
3. What's the overall impact (financially) on R Enterprises if the parts are made internally?
4. At what point would it not be cost effective for Rey Enterprises to produce the part internally?
Explanation / Answer
1. What's the maximum amount Division B would be willing to pay Division A?
Maximum Total amount Division B would be willing to pay Division A = 40000*48
Maximum Total amount Division B would be willing to pay Division A = 1920000
Note :
Maximum amount per part Division B would be willing to pay Division A = 48
2. What's the minimum amount Division A would be willing to charge Division B?
Relevant cost for 1st 20000 part = Variable cost = 30
Relevant cost for beyond 1st 20000 part = sale value less selling cost = 60-2 = 58
Minimum total amount Division A would be willing to charge Division B = 20000*30 + (40000-20000)*58
Minimum total amount Division A would be willing to charge Division B = $ 1,760,000
Note :
Minimum amount per part , Division A would be willing to charge Division B = Minimum total amount Division A would be willing to charge Division B /No of part
Minimum amount per part , Division A would be willing to charge Division B = 1760000/40000
Minimum amount per part , Division A would be willing to charge Division B = 44
3. What's the overall impact (financially) on R Enterprises if the parts are made internally?
Overall impact (financially) on R Enterprises, Profit would increase by = Maximum Total amount Division B would be willing to pay Division A - Minimum total amount Division A would be willing to charge Division B
Overall impact (financially) on R Enterprises, Profit would increase by = 1920000-1760000
Overall impact (financially) on R Enterprises, Profit would increase by = $ 160000
4. At what point would it not be cost effective for Rey Enterprises to produce the part internally?
At 20000 Unit , Incremental Profit = (48-30)*20000= 360000
No of Unit , indifference point = 20000 + Incremental Profit/Change in price
No of Unit , indifference point = 20000 + 360000/(58-48)
No of Unit , indifference point = 56000
Answer
At 56000 Unit or more it would not be cost effective for Rey Enterprises to produce the part internally
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