Question

The following data apply to questions 5-9. The Santa Fe Manufacturing Company has two divisions in Kansas, the Holton Division and the Derby Division. Currently, Derby buys a part (10,000 units) from Holton for $16 per unit. Holton has purchased new equipment and wants to increase the price to Derby to $18 per unit. The controller of Derby claims that she cannot afford to go that high, as it will decrease the division's profit to near zero. Derby can buy the part from an outside supplier for $16 per unit. The incremental costs per unit that Santa Fe incurs to produce each unit are Holton's variable costs of $12. Fixed costs per unit for Holton with the recent purchase of equipment are $5.

Given Answer:D

Can someone help me with this question, please? the answer is D but can someone give me a good explanation as to why? please help and thank you!

Answer 1

First, we see company as a whole :

Company is incurring $5 per unit for Holtan Division. This cost is fixed cost, whether or not company produce parts in Holtan Division.

Now, if material is produced in Holtan Division, then cost per unit will be : $12 Variable cost + $ 5 Fixed Cost = $ 17/ Unit

and, if material is purchased from external buyer, then cost per unit will be : $ 16 Buying cost + $ 5 Fixed Cost + $ 21/unit

Hence, Company should produce in house parts in Holtan Division and Derby should buy from it. It will save $ 3 (21-17) per unit.

Second, for Derby Division only

Cost per unit, if purchase from Holtan : $ 18/unit

Cost per unit, if purchase from external source : $ 16/unit

So, Derby division could save $2/unit , if they buy from external supplier. So, they should buy from external supplier.