Question

Division P of Launch Corporation has the capacity for making 75,000 wheel sets per year and regularly sells 60,000 each year on the outside market. The regular sales price is $100 per wheel set, and the variable production cost per unit is $65. Division Q of Launch Corporation currently buys 30,000 wheel sets (of the kind made by Division P) yearly from an outside supplier at a price of $90 per wheel set. If Division Q were to buy the 30,000 wheel sets it needs annually from Division P at $87 per wheel set, the change in annual net operating income for the company as a whole, compared to what it is currently, would be:

Answer 1

Answer:

effect on annual operating income = $225,000 increase

Explanation:

if division Q were to buy 30,000 wheel sets from division P, then division P's income would be reduced by = contribution margin times 15,000 wheels = ($100 - $65) x 15,000 = $525,000. Division P's lost sales would be 15,000 because it has 15,000 in spare capacity.

but division Q's costs would decrease by = savings per wheel set x 30,000 wheel sets = ($90 - $65) x 30,000 =  $750,000. Intercompany sales must be recorded at COGS on the consolidated balance sheet.

effect on annual operating income = money saved - lost sales = $750,000 - $525,000 = $225,000 increase