Question

Edwards Inc. manufactures electronics. It consists of several divisions operating as profit SBUs. Division A desires to purchase materials from Division B at a price of $85 per unit. Division B can produce 25,000 units at full capacity, and is currently operating at 90% capacity, selling only to outside customers at a variable cost of $80 per unit. B's customers pay $115 per unit. Division A pays an outsourced company $110 per unit. If purchased form Division B, B's variable costs would be $10 less because it saves on marketing expenses. Division A requires 10,000 units.

Required:

How would Division B selling to Division A affect Division A's purchasing costs? How would it affect Division B? What solution would be best for Edwards Inc., assuming Division B has the ability to operate at full capacity?

Answer 1

How would Division B selling to Division A affect Division A's purchasing costs?

Division A's purchasing cost will decline by $250000 (10000 units * (110 - 85))

How would it affect Division B?

Division B's Current contribution margin = 22500 * 35 = $787500

if 10000 units sold to Division A, Contribution margin will be = (15000 * 35) + (10000 * 15) = $675000

Division B's profit will decline by $112500

What solution would be best for Edwards Inc., assuming Division B has the ability to operate at full capacity?

If Division B sells 10000 units to Division A, Edwards Inc. overall profit will increase by $137500 (250000 - 112500)

If Division B has the ability to operate at full capacity, it is best for Edwards Inc. if division B sells 10000 units to Division A.