Keller Company produces computers and computer components. The company is organized into several divisions that operate essentially as autonomous companies. The firm permits division managers to make investment and production-level decisions. The division managers can also decide whether to sell to other divisions or to outside customers.
Networks Division produces a critical component for computers manufactured by Computers Division. It has been selling this component to Computers for $2,000 per unit. Networks recently purchased new equipment for producing the component. To offset its higher depreciation charges, Networks increased its price to $2,200 per unit. The manager of Networks has asked the president to instruct Computers to purchase the component for the $2,200 price rather than to permit Computers to purchase externally for $2,000 per unit. The following information is obtained from the company’s records: Computers’ annual purchases of the component, 400 units; Networks’ variable costs per unit, $1,400; Networks’ fixed costs per unit, $400.
a. Assume that the firm has no alternative uses for Networks’ idle capacity. Will the company as a whole benefit if Computers purchases the component externally for $2,000? Explain.
b. Assume that the firm can use the idle capacity of Networks for other purposes, resulting in cash operating savings of $150,000. Will the company as a whole benefit if Computers purchases the component externally for $2,000? Explain.
c. Assume the same facts as in part b. except that the outside market price drops to $1,800 per unit. Will the company as a whole benefit if Computers purchases the component externally for $1,800? Explain.
d. As president, how would you respond to the manager of Networks? Discuss each scenario described in parts a., b., and c.