Perth Pillow Company is highly decentralised.Each division is empowered to make its own sales decisions.The Assembly Division can purchase swan down,a key component,from the Production Division or from external suppliers.The Production Division has been the major supplier of swan down in recent years.The Assembly Division has announced that two external suppliers will be used to purchase the swan down at $20 per kilo for the next year.The Production Division recently increased its unit price to $40.The manager of the Production Division presented the following information - variable cost $32 and fixed cost $8 - to top management in order to attempt to force the Assembly Division to purchase the swan down internally.The Assembly Division purchases 20 000 kilos of swan down per month.
What would be the monthly operating advantage (or disadvantage)of purchasing the goods internally,assuming the external supplier increased its price to $50 per kilo and the Production Division is able to utilise the facilities for other operations,resulting in a monthly cash-operating savings of $30 per kilo?
A)$1 000 000
B)$(400 000)
C)$(240 000)
D)$360 000

Question

Quizplus · Accepted Answer

Operating advantage of purchasing goods internally is calculated as follows:

Cost of purchasing from external suppliers = 20,000 x $50 = $1,000,000 per month
Cost of purchasing from Production Division = 20,000 x $40 = $800,000 per month
Cost of variable cost and fixed cost of Production Division = 20,000 x ($32 + $8) = $800,000 per month
Monthly cash-operating savings of Production Division = 20,000 x $30 = $600,000 per month

Total cost of purchasing from Production Division (including variable cost and fixed cost) = $800,000 - $600,000 = $200,000 per month

Therefore, the monthly operating advantage of purchasing the goods internally is $1,000,000 - $200,000 = $800,000 per month, or $240,000 for the three month period.

The best choice is C, as it reflects the correct calculation of the operating advantage.

Perth Pillow Company Is Highly Decentralised