Question

The Assembly Division of Canadian 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 labour 20 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 Assembly Division has been buying batteries from outside sources for $130 each. Required: a. Should the Electrical Division manager accept the offer as is, make a counter offer, or reject the offer? Explain. b. From the company's perspective, will the internal sales be of any benefit? Explain

Answer 1

We would determine incremental profit or loss from accepting the offer
Sales revenue from internal sales	$104
Less: Variable expenses	$72	(40+20+12)
Incremental profits	$32
No of units sold internally	$90,000
Total increase in profits	$2,880,000
Electrical division has excess capacity and thus it should accept the offer as it would increase its profits by $2,880,000
b.
Calculate incremental profit for company from internal sales
Savings in cost from outside purchase	$11,700,000	90000*130
Additional expenses	-$6,480,000	90000*72
Increase in profits	$5,220,000
From company’s perspective also the internal sales is preferable as it would increase profits by $5,220,000