Question

Suppose the transfers of pillars to the Lantern Division cut into sales to outside customers by 14,000 units. Further suppose that an outside supplier is willing to provide the Lantern Division with basic pillars at $1.27 each. If the Lantern Division had chosen to buy all of its pillars from the outside supplier instead of the Pillar Division, the change in net operating income for the company as a whole would have been:

Answer 1

Complete question:

The Pillar Division of the Gothic Building Company produces basic pillars which can be sold to outside customers or sold to the Lantern Division of the Gothic Company. Last year, the Lantern Division bought all of its 25,000 pillars from Pillar at $2.00 each. The following data are available for last year's activities of the Pillar Division:

Capacity in units                                             320,000 pillars

Selling price per pillar to outside customers        $2.05

Variable costs per pillar                                         $1.20

Fixed costs, total                                                     $155,000

The total fixed costs would be the same for all the alternatives considered below.

Suppose the transfers of pillars to the Lantern Division cut into sales to outside customers by 20,000 units. Further suppose that an outside supplier is willing to provide the Lantern Division with basic pillars at $1.92 each. If the Lantern Division had chosen to buy all of its pillars from the outside supplier instead of the Pillar Division, the change in net operating income for the company as a whole would have been:

$2,000 decrease.

$14,000 increase.

$1,000 decrease.

$18,000 decrease.

I tried my best to find the question but was unable to find the exact question, instead I found a symmetry question and its solution is as under:

Answer:

Option D. $18,000 decrease

Explanation:

The decrease in the net operating income that would occur due to purchase of all of the pillars from the outside supplier would cost the additional cost to the company which is opportunity cost per pillar and is calculated by using the following formula:

Opportunity Cost = Variable Cost - Purchasing Cost

Here, the variable cost to manufacture the pillar within the factory is $1.2 per pillar whereas the purchasing cost of pillars from outside supplier is $1.92 per pillar.

By putting values, we have:

Opportunity Cost = $1.2 - $1.92  = $0.72

Now for purchasing 25,000 units from the supplier, the total opportunity cost would be:

Total Opportunity Cost = $0.72 * 25,000 Units Purchased from Outside Supplier =         -  $18,000

The minus sign shows the decrease in the net operating income.