Franklin Industrial Equipment Corporation manufactures lawn mowers and snow blowers. It also manufactures engines that are used by the Lawn Mower Assembly Division (LMAD). The Engine Division (ED) also sells about 40% of its output to the outside market (these are multipurpose engines). Its annual capacity is 150,000 units and annual output is 135,000 units. All engines sold internally to the LMAD are priced at cost plus 20% markup.
In January 2020, the Snow Blower Assembly Division (SBAD) approached the ED to 'buy' 20,000 engines. Jean Wyse, the controller of ED, computed the costs of manufacturing these engines as follows:
$\begin{array}{lrr}
&\text {Total}&\text {Per unit}\
\text { Materials } & \$ 300,000 & \$ 15.00\
\text { Labor } & 400,000 & 20.00 \
\text { Special equipment } & 36,000 & 1.80 \
\text { Quality inspection } & 24,000 & 1.20 \
\text { Other manufacturing costs } & 350,000 & 17.50\
\text { Total costs }&\$1,110,000&\$55.50
\end{array}$
Wyse quoted a price of $66.60 for each engine transferred to the SBAD. Jeb Hart, the manager of SBAD, was furious to note that the ED was "trying to make money off a sister division." He argued that the price must include only the cost of materials, as all other costs will be incurred irrespective of whether or not SBAD places the order for 20,000 engines. Mark Matley, the production manager of ED, pointed out that the special equipment will be purchased only for fulfilling this internal order. Moreover, he argued that inspection must also be done just like on all other engines; therefore, the inspection costs must also be included. Labor is paid a flat monthly salary. Other manufacturing costs include both variable and fixed components (in roughly equal proportion).
Required:
(a) Given that excess capacity exists, what is the minimum price that the ED should charge to the SBAD?
(b) What are the pros and cons of internal sourcing?

Question

Franklin Industrial Equipment Corporation manufactures lawn mowers and snow blowers. It also manufactures engines that are used by the Lawn Mower Assembly Division (LMAD). The Engine Division (ED) also sells about 40% of its output to the outside market (these are multipurpose engines). Its annual capacity is 150,000 units and annual output is 135,000 units. All engines sold internally to the LMAD are priced at cost plus 20% markup.
In January 2020, the Snow Blower Assembly Division (SBAD) approached the ED to 'buy' 20,000 engines. Jean Wyse, the controller of ED, computed the costs of manufacturing these engines as follows:
 $\begin{array}{lrr}
&\text {Total}&\text {Per unit}\
\text { Materials } & \$ 300,000 & \$ 15.00\
\text { Labor } & 400,000 & 20.00 \
\text { Special equipment } & 36,000 & 1.80 \
\text { Quality inspection } & 24,000 & 1.20 \
\text { Other manufacturing costs } & 350,000 & 17.50\
\text { Total costs }&\$1,110,000&\$55.50
\end{array}$ 
Wyse quoted a price of $66.60 for each engine transferred to the SBAD. Jeb Hart, the manager of SBAD, was furious to note that the ED was "trying to make money off a sister division." He argued that the price must include only the cost of materials, as all other costs will be incurred irrespective of whether or not SBAD places the order for 20,000 engines. Mark Matley, the production manager of ED, pointed out that the special equipment will be purchased only for fulfilling this internal order. Moreover, he argued that inspection must also be done just like on all other engines; therefore, the inspection costs must also be included. Labor is paid a flat monthly salary. Other manufacturing costs include both variable and fixed components (in roughly equal proportion).
Required:
(a) Given that excess capacity exists, what is the minimum price that the ED should charge to the SBAD?
(b) What are the pros and cons of internal sourcing?

Quizplus · Accepted Answer

The Answer of Franklin Industrial Equipment Corporation manufactures lawn mowers and snow blowers. It also manufactures engines that are used by the Lawn Mower Assembly Division (LMAD). The Engine Division (ED) also sells about 40% of its output to the outside market (these are multipurpose engines). Its annual capacity is 150,000 units and annual output is 135,000 units. All engines sold internally to the LMAD are priced at cost plus 20% markup.
In January 2020, the Snow Blower Assembly Division (SBAD) approached the ED to 'buy' 20,000 engines. Jean Wyse, the controller of ED, computed the costs of manufacturing these engines as follows:
 $\begin{array}{lrr}
&\text {Total}&\text {Per unit}\
\text { Materials } & \$ 300,000 & \$ 15.00\
\text { Labor } & 400,000 & 20.00 \
\text { Special equipment } & 36,000 & 1.80 \
\text { Quality inspection } & 24,000 & 1.20 \
\text { Other manufacturing costs } & 350,000 & 17.50\
\text { Total costs }&\$1,110,000&\$55.50
\end{array}$ 
Wyse quoted a price of $66.60 for each engine transferred to the SBAD. Jeb Hart, the manager of SBAD, was furious to note that the ED was "trying to make money off a sister division." He argued that the price must include only the cost of materials, as all other costs will be incurred irrespective of whether or not SBAD places the order for 20,000 engines. Mark Matley, the production manager of ED, pointed out that the special equipment will be purchased only for fulfilling this internal order. Moreover, he argued that inspection must also be done just like on all other engines; therefore, the inspection costs must also be included. Labor is paid a flat monthly salary. Other manufacturing costs include both variable and fixed components (in roughly equal proportion).
Required:
(a) Given that excess capacity exists, what is the minimum price that the ED should charge to the SBAD?
(b) What are the pros and cons of internal sourcing?

Franklin Industrial Equipment Corporation Manufactures Lawn Mowers and Snow Blowers