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		$195
Division A’s annual purchases		14,500	units
Division B’s variable costs per unit		$185
Division B’s fixed costs, per year	$	1,340,000
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 $235,000 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 $12, 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

Answer:

1	Cost of purchasing from outside (14500 x $195)	$      28,27,500
	Less: Savings in Division B's variable costs (14500 x $185)	$      26,82,500
	Net cost (benefit) of buying from outside	$        1,45,000
		.
2-a.	Cost of purchasing from outside (14500 x $195)	$      28,27,500
	Less: Savings in Division B's variable costs (14500 x $185)	$      26,82,500
	Less: Savings in Division B's fixed costs	$        2,35,000
	Net cost (benefit) of buying from outside	$         -90,000
2-b.	Yes, Division A should purchase from the outside market.
3-a.	Cost of purchasing from outside [14500 x ($195 - $12)]	$      26,53,500
	Less: Savings in Division B's variable costs (14500 x $185)	$      26,82,500
	Net cost (benefit) of buying from outside	$      -1,21,000
3-b.	Yes, Division A should purchase from the outside market.