Division A makes a part with the following characteristics:

Division B, another division of the same company, would like to purchase 5,000 units of the part each period from Division A. Division B is now purchasing these parts from an outside supplier at a price of $24 each.
-Suppose that Division A is operating at capacity and can sell all of its output to outside customers at its usual selling price.If Division A sells the parts to Division B at $24 per unit (Division B's outside price),what will be the effect on the operating income of company as a whole?
A) Higher by $5,000 each period.
B) Lower by $15,000 each period.
C) Lower by $5,000 each period.
D) There will be no change in the status of the company as a whole.

Question

Division A makes a part with the following characteristics:

Division B, another division of the same company, would like to purchase 5,000 units of the part each period from Division A. Division B is now purchasing these parts from an outside supplier at a price of $24 each.
-Suppose that Division A is operating at capacity and can sell all of its output to outside customers at its usual selling price.If Division A sells the parts to Division B at $24 per unit (Division B's outside price),what will be the effect on the operating income of company as a whole?
A) Higher by $5,000 each period. 
B) Lower by $15,000 each period. 
C) Lower by $5,000 each period. 
D) There will be no change in the status of the company as a whole.

Quizplus · Accepted Answer

If Division A sells the parts to Division B at $24 per unit, it will not make any profit since the price is equal to its variable cost. Therefore, the company's operating income will decrease by the profit it would have earned if it had sold to an outside customer at its usual selling price. Let's assume the usual selling price is $30 per unit, so the profit per unit is $6.

The total profit that Division A would have earned from selling 5,000 units to outside customers is:

5,000 units × $6 profit per unit = $30,000

Therefore, if Division A sells 5,000 units to Division B at $24 per unit, it will lose the opportunity to earn $30,000 in profit from selling those units to outside customers. Thus, the operating income of the company as a whole will be lower by $30,000 ÷ 6 periods = $5,000 each period.

Division a Makes a Part with the Following Characteristics