Frances Industries has two divisions (Parts and Tools). The Tools Division wants

Question

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 abou 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 $10,000,000.00

a.) 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?

b.) 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. What is the minimum price (per unit) the Parts Division should charge?

c.) 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?

Explanation / Answer

Fixed Cost Per Unit = $10,000,000 / 200,000 = $50

Since the “Variable Cost” is $40 & the fixed cost is not recovered fully, anything which is over & above $40, will bring down the fixed cost. However, the minimum price can be equal to “Variable Cost” as it will save the money for the other part of the company. So, minimum price in this scenario = $40.

If the facility is operating on full capacity, we are making a profit of $10 per unit (Sale Price – Variable Cost – Fixed Cost, all in per unit). So if we sell the product on cost, the minimum price is $90. (Market Price – Profit)

In this scenario, we can provide the initial 10,000 units at Variable Cost, i.e. $40, as it can be produced with no additional Fixed Cost & remaining 10,000 units at total cost, i.e. $90 (VC+FC). So the minimum price = ($40*10,000) + ($90*10,000) / 20,000 = $65 Per Unit

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