Elliott Division of Morehead Inc. has a capacity of 200,000 units and expects th

Question

Elliott Division of Morehead Inc. has a capacity of 200,000 units and expects the following results.

Sales (160,000 units at $4)              $640,000

Variable costs at $2                320,000

Fixed costs                              260,000

Income                                     $60,000

Pierce Division of Morehead Inc. currently purchases 50,000 units of a part for one of its products from an outside supplier for $4 per unit. Pierce's manager believes he could use a minor variation of Elliott's product instead, and offers to buy the units from Elliott at $3.50. Making the variation desired by Pierce would cost Elliott an additional $0.50 per unit and would increase Elliott's annual cash fixed costs by $20,000. Elliott's manager agrees to the deal offered by Pierce's manager.
a. What is the effect of the deal on Pierce's income?
b. What is the effect of the deal on Elliott's income?
c. What is the effect of the deal on the income of Morehead Inc. as a whole?

Explanation / Answer

GIVEN SALES PER UNIT = 4

VARIABLE COST PER UNIT = 320000/160000

= 2

FIXED COST = 260000

A] EFFECT OF THE DEAL ON PIERCE

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