Gustavsson AB, manufacturer of tractors and other heavy farm equipment, is organized along decentralised lines, with each manufacturing division operating as a separate profit centre. Each divisional manager has been delegated full authority on all decisions involving the sale of that division’s output both to outsiders and to other divisions of Gustavsson. Division C has in the past always purchased its requirement of a particular tractor-engine component from Division A. However, when informed that Division A is increasing its selling price to €150, Division C’s manager decides to purchase the engine component from outside suppliers. Division C can purchase the component for €135 on the open market. Division A insists that, because of the recent installation of some highly specialised equipment and the resulting high depreciation charges, it will not be able to earn an adequate return on its investment unless it raises its price. Division A’s manager appeals to top management of Gustavsson for support in the dispute with Division C and supplies the following operating data:
C’s annual purchases of tractor-engine component…………………………1000 units
A’s variable costs per unit of tractor-engine component…………………………€120
A’s fixed costs per unit of tractor-engine component……………………………..€20
1. Assume that there are no alternative uses for internal facilities. Determine whether the company as a whole will benefit if Division C purchases the component from outside suppliers for €135 per unit.
2. Assume that internal facilities of Division A would not otherwise be idle. By not producing the 1000 units for Division C, Division A’s equipment and other facilities would be used for other production operations that would result in annual cash-operating savings of €18000. Should Division C purchase from outside suppliers?
3. Assume that there are no alternative uses for Division A’s internal facilities and that the price from outsiders drops €20. Should Division C purchase from outside suppliers?