Question

ABC Division makes wood furniture. Most of their lumber is purchased from XYZ Division. ABC Division is looking into a new product, that will sell for $150, and wants to purchase the lumber from XYZ. Planned production is 800 units, and would use otherwise idle capacity at ABC. The external purchase price for the lumber would be $60/chair. Corporate has a policy that internal transfers are to be priced at variable cost plus allocated fixed costs.

Assume the following costs for production of one unit.

XYZ			ABC
Variable Cost	$40		Variable Cost:
Allocated Fixed Cost	$30		Manufacturing*	$75
Full Cost	$70		Selling	$10
			Total Variable Cost	$85
			*Not including the cost of lumber

a.) If corporate policy is followed, would the manager of ABC buy the lumber from XYZ? Why/why not?

b.) If corporate policy is followed, calculate the contribution margin for the entire company if ABC decides to buy from XYZ, and is able to sell all 800 chairs.

c.) If XYZ has excess capacity, what is the minimum price its managers should be willing to accept?

Answer 1

Answer-

a)If corporate policy is followed ,the manager should buy the lumber from XYZ.

Reason-IF corporate pocily is followed(Buy lumber fromXYZ) then total cost-

Fixed cost	$50
Variable cost	$30
Total cost	$80

-IF corporate pocily is not followed(Buy lumber from outside) then total cost-

Purchased Price	$60
Fixed cost( Fixedcost always occur even goods purchased from outside)	$30
Total Cost	$90

b) Ifcorporate policy is followed and 800 chairs are sold then contribution margin for the entire company is-

Total sales/revenue(800 chairs*$150)	$120000
Less-Total cost(800 Chairs*$70)	$56000
Contribution	$64000

c) If XYZ has excess capacity minimum price is $60/chairs( variable cost + FixedCost)