Question

Truball Inc., which manufactures sports equipment, consists of several operating divisions. Division A has decided to go outside the company to buy materials since division B plans to increase its selling price for the same materials to $200. Information for division A and division B follows:

Outside price for materials		$180
Division A’s annual purchases		13,000	units
Division B’s variable costs per unit		$170
Division B’s fixed costs, per year	$	1,310,000
Division B’s capacity utilization		100	%

Required:

1. Assume that division B cannot sell its materials to outside buyers. Calculate the net cost or benefit to the company as a whole if Division A purchases the materials outside the company.

2-a. Assume that division B can save $220,000 in fixed costs if it does not manufacture the material for Division A. Calculate the net cost or benefit to the company as a whole for A to purchase outside the company.

2-b. From the standpoint of the effect of the transaction on the company as a whole, should Division A purchase from the outside market?

3-a. Assume the situation in Requirement 1. If the outside market value for the materials drops $23, calculate the net cost or benefit to the company as a whole for A to purchase outside the company.

3-b. From the standpoint of the effect of the transaction on the company as a whole, should Division A purchase from the outside market?

Answer 1

1.

Calculation In Million ($)
Purchase Costs from outside ($180*13,000)	$ 2,340,000.00
Less: Savings of B's Variable Cost ($170*13,000)	$ 2,210,000.00
Net Cost to buy Outside	$    130,000.00

Division A should buy inside from division B.

2-a.

Calculation in Million Dollars
Purchase Costs from Outside ($180*13,000)	$ 2,340,000.00
Less: Savings of B's Variable Costs ($170*13,000)	$ 2,210,000.00
Less:Savings of B Material Assignment	$    220,000.00
Net (Benefit) to Buy Outside	$     (90,000.00)

2-b

From the above calculation it is evident that due to the savings in division B, division A should buy from outside. Thus the answer is YES.

3-a.

Calculation in Million ($)
Purchase Costs From Outside [($180-$23)*13,000]	$ 2,041,000.00
Less: Savings of B's Variable Cost ($170*13,000)	$ 2,210,000.00
Net (Benefit) to Buy Outside	$   (169,000.00)

3-b.

From the above calculation it is evident that due to drop down in unit cost from outsiders, division A should buy from outside rather than from division B. Thus the answer is YES.