Question

The Gear Division makes a part with the following characteristics:

Production capacity 25,000 units
Selling price to outside customers $ 18
Variable cost per unit $ 11
Fixed cost, total $ 100,000
Motor Division of the same company would like to purchase 10,000 units each period from the Gear Division. The Motor Division now purchases the part from an outside supplier at a price of $17 each. Suppose that the Gear Division is operating at capacity and can sell all of its output to outside customers. If the Gear Division sells the parts to Motor Division at $17 per unit, the company as a whole will be:
a. better off by $10,000 each period.
b. worse off by $20,000 each period.
c. worse off by $10,000 each period.
d. There will be no change in the status of the company as a whole.

Answer 1

Effect on income= -10,000

Step-by-step explanation:

Giving the following information:

Production capacity 25,000 units

Selling price to outside customers $ 18

Variable cost per unit $ 11

Fixed cost, total $ 100,000

First, we need to calculate the unitary total production cost:

Total unitary cost= (100,000/25,000) + 11

Total unitary cost= $15

The company can sell all of its production to outside customers and gain $3 from the sale. But, by selling to the Motor Division, it gains $2.

Now, the effect on income:

Effect on income= increase in income by not buying the part - decrease in sales revenue for not selling to outside customers

Effect on income= 10,000*2 - 10,000*3

Effect on income= 20,000 - 30,000

Effect on income= -10,000