The Gear Division makes a part with the following characteristics:
$$\begin{array} { | l | r | }
\hline \text { Production capacity } & 25,000 \text { units } \
\hline \text { Selling price to outside customers } & \$ 18 \
\hline \text { Variable cost per unit } & \$ 11 \
\hline \text { Fixed cost, total } & \$ 100,000 \
\hline
\end{array}$$Motor Division of the same company would like to purchase 10,000 units each period from the Gear Division.The Motor Division now purchases the part from an outside supplier at a price of $17 each.Suppose that the Gear Division is operating at capacity and can sell all of its output to outside customers.If the Gear Division sells the parts to Motor Division at $17 per unit,the company as a whole will be:
A) better off by $10,000 each period.
B) worse off by $20,000 each period.
C) worse off by $10,000 each period.
D) There will be no change in the status of the company as a whole.

Question

The Gear Division makes a part with the following characteristics: 
$$\begin{array} { | l | r | } 
\hline \text { Production capacity } & 25,000 \text { units } \
\hline \text { Selling price to outside customers } & \$ 18 \
\hline \text { Variable cost per unit } & \$ 11 \
\hline \text { Fixed cost, total } & \$ 100,000 \
\hline
\end{array}$$Motor Division of the same company would like to purchase 10,000 units each period from the Gear Division.The Motor Division now purchases the part from an outside supplier at a price of $17 each.Suppose that the Gear Division is operating at capacity and can sell all of its output to outside customers.If the Gear Division sells the parts to Motor Division at $17 per unit,the company as a whole will be:
A) better off by $10,000 each period.
B) worse off by $20,000 each period.
C) worse off by $10,000 each period.
D) There will be no change in the status of the company as a whole.

Quizplus · Accepted Answer

If the Gear Division sells the parts to the Motor Division at $17 per unit, the company as a whole will be worse off by $10,000 each period. This is because the Motor Division is currently purchasing the part from an outside supplier at the same price of $17 each. Therefore, if the Gear Division sells the parts to the Motor Division for $17 per unit, there will be no cost savings for the company as a whole. However, the Gear Division will lose out on the opportunity to sell its products to outside customers at a potentially higher price. Hence, the Gear Division will lose $17 per unit in revenue. 
Therefore, the company as a whole will be worse off by $10,000 each period if the Gear Division sells the parts to the Motor Division at $17 per unit.

The Gear Division Makes a Part with the Following Characteristics