Division X makes a part with the following characteristics: Division Y of the same company would like to purchase 10,000 units each period from Division X. Division Y now purchases the part from an outside supplier at a price of $17 each. Suppose Division X has ample excess capacity to handle all of Division Y's needs without any increase in fixed costs and without cutting into sales to outside customers. If Division X refuses to accept the $17 price internally and Division Y continues to buy from the outside supplier, the company as a whole will be:
A) worse off by $70,000 each period.
B) better off by $10,000 each period.
C) worse off by $60,000 each period.
D) worse off by $20,000 each period.
E) better off by $60,000 each period.

Question

Division X makes a part with the following characteristics:  Division Y of the same company would like to purchase 10,000 units each period from Division X. Division Y now purchases the part from an outside supplier at a price of $17 each. Suppose Division X has ample excess capacity to handle all of Division Y's needs without any increase in fixed costs and without cutting into sales to outside customers. If Division X refuses to accept the $17 price internally and Division Y continues to buy from the outside supplier, the company as a whole will be:
A) worse off by $70,000 each period. 
B) better off by $10,000 each period. 
C) worse off by $60,000 each period. 
D) worse off by $20,000 each period. 
E) better off by $60,000 each period.

Quizplus · Accepted Answer

Instead of incurring a cost of $11 per unit, the company would have to incur a cost of $17 per unit to purchase from an outside supplier. Therefore, the company would be worse off by $60,000 per period = ($17 per unit − $11 per unit) × 10,000 units per period.

Division X Makes a Part with the Following Characteristics