3. Poudre Industries is a diversified manufacturing company with a decentralized

Question

3. Poudre Industries is a diversified manufacturing company with a decentralized management structure. Each division is treated as a profit center. One of these divisions is Wellington Processing, which produces a variety of products at a single plant. Wellington operates below capacity. Wellington's biggest customer for a major product, XB42, is Eaton Industries, another division of Poudre. At the normal production level of 30,000 units, XB42 costs $840 to produce: direct materials, $310; direct labor, $80; overhead, $450). The composition of the overhead cost is 60% fixed and 40% variable. The current selling price of XB42 is $1,120/unit. Eaton has been paying $1,075/unit, with the discount reflecting lower transaction costs for Wellington. Eaton has found another supplier for XB42 at a price of $690/unit. Wellington's president refuses to meet this price, as it is below cost, and she will lose money on the sale. Required: As CEO of Poudre, discuss the factors to be considered in resolving the pricing dispute between Wellington and Eaton. 22 points

Explanation / Answer

Poudre Industries: Wellington Processing Eaton Industries XB42 1075 Production Level 30000 Direct Material 310 Direct Labor 80 Variable OH 180 Fixed OH 270 Total Cost 570 Selling Price 1120 Eaton Industries: Current Payment 1075 External Supplier Offer 690 Relevant Cost of XB42: Direct Material 310 Direct Labor 80 Variable OH 180 Total Relevant Cost 570 External Supplier Offer 690 Loss on Buying from External Supplier -120 (570-690) Loss incurred by Eaton while buying from external Supplier will be consolidated in Poudre Industries, which will lead to reducing Profits of consolidated enterprise So, External Supplier offer should be rejected and inhouse buying should continue

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