Ferry Metalworks produces high-grade pig iron in its single blast furnace in Bedford, Pennsylvania. Coal from nearby mines is converted into coke in company-owned ovens, and 80% of the coke produced is used in the blast furnace. The management of the mill is experimenting with divisional profit reporting and control and has established the blast furnace as well as the coke-producing activity as profit centers. Coke used by the blast furnace is charged to that profit center at $6 per ton, which approximates the current market price less costs of marketing (including substantial freight costs). The remaining 20% of the coke produced at a normal annual volume output of 80,000 tons is sold to other mills in the area at $7.50 per ton.
The cost of coal and other variable costs of coke production amount to $4 per ton. Fixed costs of the coke division amount to $60,000 a year.
The blast furnace manager, with authority to purchase outside, has found a reliable, independent coke producer who has offered to sell coke at a delivered price of $5 per ton on a long-term contract. The manager of Ferry Metalworks's coke division claims the division cannot match that price and maintain profitable operations.
The manager of the coke division indicates that with an additional expenditure of $60,000 annually for fixed productive and delivery equipment, the division's entire annual normal output could be sold to outside firms at $6 per ton, FOB the Ferry Metalworks plant. Other marketing expenses will be $.50 per ton. The increased fixed costs would reduce variable production costs by $1 per ton.
Required:
(1) Advise the coke division manage whether to accept the outside offer, assuming that Ferry Metalworks cannot increase its sales of coke to outsiders above 20% of normal production.
(2) Prepare calculations to aid executive management in deciding whether to make the additional investment and sell the entire coke division's output to outsiders.