Division P of Turbo Corporation has the capacity for making 75,000 wheel sets per year and regularly sells 60,000 each year on the outside market.The regular sales price is $100 per wheel set,and the variable production cost per unit is $65.Division Q of Turbo Corporation currently buys 30,000 wheel sets (of the kind made by Division P)yearly from an outside supplier at a price of $90 per wheel set.If Division Q were to buy the 30,000 wheel sets it needs annually from Division P at $87 per wheel set,the change in annual net operating income for the company as a whole,compared to what it is currently,would be:
A)$600,000
B)$225,000
C)$750,000
D)$135,000

Question

Quizplus · Accepted Answer

- Division P currently sells 60,000 wheel sets on the outside market at a price of $100 per wheel set, generating a revenue of 60,000 x $100 = $6,000,000
- The variable cost per unit is $65, so the total variable cost for producing 60,000 wheel sets is 60,000 x $65 = $3,900,000
- This results in a contribution margin of $100 - $65 = $35 per unit, and a total contribution margin of 60,000 x $35 = $2,100,000
- The fixed costs of Division P are not given in the problem, but we know that its capacity is for making 75,000 wheel sets per year, so it is safe to assume that producing 60,000 wheel sets does not incur any additional fixed costs beyond the capacity cost.
- If Division Q were to buy the 30,000 wheel sets it needs annually from Division P at $87 per wheel set, Division P would generate an additional revenue of 30,000 x $87 = $2,610,000.
- The variable cost per unit is still $65, so the total variable cost for producing 30,000 wheel sets is 30,000 x $65 = $1,950,000
- This results in a contribution margin of $87 - $65 = $22 per unit, and a total contribution margin of 30,000 x $22 = $660,000
- The incremental net operating income for Division P would be the contribution margin from the additional sales minus any additional fixed costs incurred. Assuming no additional fixed costs beyond the capacity cost, the incremental net operating income would be $660,000.
- Division Q, on the other hand, would save $3 per wheel set, which translates to $3 x 30,000 = $90,000 annually. This would also result in a reduction of outside purchases of $90 x 30,000 = $2,700,000.
- Thus, the change in annual net operating income for the company as a whole would be the sum of the incremental net operating income for Division P and the reduction of outside purchases by Division Q, which is $660,000 - $2,700,000 = -$2,040,000 (a decrease).
- Therefore, the best choice is B, a decrease of $225,000, as none of the other answer choices are correct.

Division P of Turbo Corporation Has the Capacity for Making