The Wheel Division of Frankov Corporation has the capacity for making 75,000 wheel sets per year and regularly sells 60,000 each year on the outside market.The regular sales price is $100 per wheel set,and the variable production cost per unit is $65.The Retail Division of Frankov Corporation currently buys 30,000 wheel sets (of the kind made by the Wheel Division)yearly from an outside supplier at a price of $90 per wheel set.If the Retail Division were to buy the 30,000 wheel sets it needs annually from the Wheel Division at $87 per wheel set,the change in annual net operating income for the company as a whole,compared to what it is currently,would be:
A) $600,000.
B) $225,000.
C) $750,000.
D) $135,000.

Question

Quizplus · Accepted Answer

Currently, the Wheel Division produces 75,000 wheel sets but sells only 60,000 on the outside market. This means that the division has excess capacity of 15,000 units that can be sold to the Retail Division for $87 per unit.

Selling 30,000 units to the Retail Division at $87 per unit would generate additional revenue of $2,610,000 (($87 - $65) x 30,000)). However, this would result in lost sales of 30,000 units on the outside market, which represents a revenue loss of $3,000,000 (30,000 units x $100 per unit).

Therefore, the change in total annual revenue would be a net loss of $390,000. However, the company would save $300,000 in purchasing costs by buying from its own Wheel Division instead of an outside supplier.

Thus, the net change in annual operating income for the company as a whole would be an increase of $90,000 ($300,000 - $390,000), which is option B.

The Wheel Division of Frankov Corporation Has the Capacity for Making