The Dairy Division of Famous Foods, Inc.produces and sells milk to outside customers.The operation has the capacity to produce 200,000 gallons of milk a year.Last year's operating results were as follows: $$\begin{array} { l r }
\text { Sales } ( 160,000 ) \text { gallons } & \$ 500,000 \
\text { Variable costs } & 312,000 \
\text { Contribution margin } & 188,000 \
\text { Fixed costs } & 100,000 \
\text { Net Income } & \$ 88,000
\end{array}$$
- Assume the Dairy Division is operating at capacity.If the Yogurt Division wants to purchase 30,000 gallons of milk from the Dairy Division, what is the minimum price that will allow the Dairy Division to maintain its current net income?

Question

The Dairy Division of Famous Foods, Inc.produces and sells milk to outside customers.The operation has the capacity to produce 200,000 gallons of milk a year.Last year's operating results were as follows: $$\begin{array} { l r } 
\text { Sales } ( 160,000 ) \text { gallons } & \$ 500,000 \
\text { Variable costs } & 312,000 \
\text { Contribution margin } & 188,000 \
\text { Fixed costs } & 100,000 \
\text { Net Income } & \$ 88,000
\end{array}$$
- Assume the Dairy Division is operating at capacity.If the Yogurt Division wants to purchase 30,000 gallons of milk from the Dairy Division, what is the minimum price that will allow the Dairy Division to maintain its current net income?

Quizplus · Accepted Answer

The Dairy Division is operating at capacity, so it cannot produce any more milk than it is currently producing. If it sells 30,000 gallons of milk to the Yogurt Division, it will have to reduce its sales to outside customers by 30,000 gallons. This will reduce its sales revenue by $500,000 x 30,000 / 160,000 = $93,750. To maintain its current net income, the Dairy Division must increase its contribution margin by $93,750. The contribution margin per gallon is $188,000 / 160,000 = $1.18. Therefore, the Dairy Division must sell the milk to the Yogurt Division for at least $1.18 per gallon to maintain its current net income.

The Dairy Division of Famous Foods, Inc - Assume the Dairy Division Is Operating at Capacity