Question

Division A produces a part with the following characteristics: Capacity in units 50,000 Selling price per unit $ 30 Variable cost per unit $ 18 Fixed cost per unit $ 3 Division B, another division in the company, would like to buy this part from Division A. Division B is presently purchasing the part from an outside source at $28 per unit. If Division A sells to Division B, $1 in variable costs can be avoided. Suppose Division A is currently operating at capacity and can sell all of the units it produces on the outside market for its usual selling price. From the point of view of Division A, any sales to Division B should be priced no lower than:

Answer 1

Division A should price the part no lower than $29 per unit to Division B, to not lose the contribution margin from external sales while operating at full capacity.

Step-by-step explanation:

From the point of view of Division A in this scenario, any sales to Division B should be priced no lower than Division A's own selling price minus the savings from the variable costs that would be avoided by selling internally. Given that Division A's selling price is $30 per unit and $1 can be avoided in variable costs if sold to Division B, the price should be no lower than $30 - $1 = $29 per unit. This pricing ensures that Division A does not lose any contribution margin it would have earned by selling externally, keeping in mind that Division A is currently operating at full capacity.

Answer 2

$29

Step-by-step explanation:

Initial Profit for division B is given thus

Profit = Unit profit * production total

at selling price of $30

Unit profit = $30 - ($18 + $3) = $9

profit = $9 * 50,000 = $450, 000

By selling to division B, Division A saves in variable cost

that is, new variable cost = $18 - $1 = $17

In order for division A to still maintain a Profit of $450,000

It must sell to Division B at a price not less than say $ x

we get x as follows

[x - ($17 + $3) ] * 50000 = 450000

x - 20 = 450000/50000

x - 20 = 9

x = 9 + 20

x = $29

sales to division B should be priced no lower than $29