Question

The Fabrication Division of American Car Company has offered to purchase 90,000 batteries from the Electrical Division for $104 per unit. At a normal volume of 250,000 batteries per year, production costs per battery are as follows:

Direct Materials: $40

Direct Manufacturing Labor: 30

Variable Factory Overhead: 12

Fixed Factory Overhead: 40

Total: $112

The Electrical Division has been selling 250,000 batteries per year to outside buyers at $136 each; capacity is 350,000 batteries per year. The Fabrication Division has been buying batteries from outside sources for $130 each.

Required:

a.             Should the Electrical Division manager accept the offer? Explain.

b.             From the company's perspective, will the internal sales be of any benefit? Explain.

*PLEASE SHOW ALL CALCULATIONS*

Answer 1

Answer for a)

In cost of production of these 90000 batteries for fabrication division, fixed overheads costs are not be considered as they are recovered from remaining 250000 batteries. Hence cost of production of 90000 batteries:

Direct material+direct labor+variable factory overhead

=$40+$30+$12=$82

Here, I will say that electrical division manager should accept the order as the department is gaining a profit of $1980000 (I.e ($104-$82)×90000 batteries) through such internal sale.

Answer for b)

The internal sales will benefit the company.

While Electrical department earn $1980000 in addition, The fabrication division save $2340000 (i.e ($130-$104)×90000 batteries) which saves the company a massive $4320000(i.e $1980000+$2340000)