Swan Company has two divisions,Hill and Paradise.Hill produces a unit that Paradise could use in its production.Paradise currently is purchasing 5,000 units from an outside supplier for $56.Hill is operating at less than full capacity and has variable costs of $30.80 per unit.The full cost to manufacture the unit is $43.40.Hill currently sells 450,000 units at a selling price of $61.60.How much will Paradise save by not purchasing from outside if a transfer price of $42 is agreed upon?
A)$70,000
B)$56,000
C)$7,000 more cost
D)$28,000

Question

Quizplus · Accepted Answer

Paradise currently purchases 5,000 units from an outside supplier for $56 per unit, giving a total cost of 5,000 × $56 = $280,000.
If Hill sells 5,000 units to Paradise at a transfer price of $42 per unit, it will earn revenue of 5,000 × $42 = $210,000. Hill's variable cost to produce 5,000 units is 5,000 × $30.80 = $154,000. Therefore, the profit earned by Hill will be $210,000 - $154,000 = $56,000.
By purchasing from Hill, Paradise will save $280,000 - $210,000 = $70,000 compared to buying from an outside supplier. Therefore, the net benefit of the transaction to Swan Company is $56,000 + $70,000 = $126,000.

Swan Company Has Two Divisions,Hill and Paradise