The Buffalo Division of Alfred Products, Inc. has the capacity to manufacture 10,000 units of a certain part each year. This part sells for $12 per unit on the outside market. The Albany Division of Alfred Products, Inc. buys 3,000 units of this part each year from Buffalo, and thus far has paid the market price. Harlow Company (an outside supplier) has recently offered to sell Albany 3,000 units per year of the same part. Buffalo Division's costs relating to the product are:
-Suppose that the Albany Division buys the 3,000 units from the outside supplier at a price of $10 per unit. Also suppose that the Buffalo Division can sell only 6,000 units on the outside market. This decision would have no effect on total fixed costs. As a result of Albany shifting its purchases to the outside supplier, the yearly net operating income of Alfred Products, Inc. as a whole will:
A) decrease by $9,000
B) increase by $9,000
C) decrease by $6,000
D) increase by $6,000

Question

The Buffalo Division of Alfred Products, Inc. has the capacity to manufacture 10,000 units of a certain part each year. This part sells for $12 per unit on the outside market. The Albany Division of Alfred Products, Inc. buys 3,000 units of this part each year from Buffalo, and thus far has paid the market price. Harlow Company (an outside supplier) has recently offered to sell Albany 3,000 units per year of the same part. Buffalo Division's costs relating to the product are: 
-Suppose that the Albany Division buys the 3,000 units from the outside supplier at a price of $10 per unit. Also suppose that the Buffalo Division can sell only 6,000 units on the outside market. This decision would have no effect on total fixed costs. As a result of Albany shifting its purchases to the outside supplier, the yearly net operating income of Alfred Products, Inc. as a whole will:
A) decrease by $9,000 
B) increase by $9,000 
C) decrease by $6,000 
D) increase by $6,000

Quizplus · Accepted Answer

The Buffalo Division can sell only 6,000 units externally, so the remaining 3,000 units would have been sold to Albany. If Albany buys from an outside supplier at $10 per unit, the company loses the internal profit margin on these 3,000 units. Assuming the internal transfer price is less than $10, the net operating income decreases by the difference in cost, which is $9,000 (3,000 units x $3 difference if internal cost was $7).