Division A makes a part with the following characteristics: Division B, another division of the same company, would like to purchase 5,000 units of the part each period from Division A. Division B is now purchasing these parts from an outside supplier at a price of $24 each.Suppose that Division A is operating at capacity and can sell all of its output to outside customers at its usual selling price. If Division A agrees to sell the parts to Division B at $24 per unit, the company as a whole will be:
A) better off by $5,000 each period.
B) worse off by $15,000 each period.
C) worse off by $5,000 each period.
D) There will be no change in the profits of the company as a whole.

Question

Division A makes a part with the following characteristics:  Division B, another division of the same company, would like to purchase 5,000 units of the part each period from Division A. Division B is now purchasing these parts from an outside supplier at a price of $24 each.Suppose that Division A is operating at capacity and can sell all of its output to outside customers at its usual selling price. If Division A agrees to sell the parts to Division B at $24 per unit, the company as a whole will be:
A) better off by $5,000 each period. 
B) worse off by $15,000 each period. 
C) worse off by $5,000 each period. 
D) There will be no change in the profits of the company as a whole.

Quizplus · Accepted Answer

If Division A sells 5,000 units to Division B at $24 each, it will receive $120,000 ($24 x 5,000) in revenue. However, since Division A is operating at capacity, it could sell those units to outside customers at its usual selling price, which is likely higher than $24. Thus, by selling to Division B at $24 per unit, Division A is forgoing additional revenue it could have earned from outside customers. As a result, the company as a whole will be worse off by $5,000 each period.

Division a Makes a Part with the Following Characteristics