The Adam Division produces a component that is used by the West Division. The cost of manufacturing the component is as follows:
- Direct materials $30
- Direct labor 8
- Variable overhead 10
- Fixed overheada 12
- Total cost $60
a Based on a practical volume of 250,000 components
- Other costs incurred by the Adam Division are as follows:
- Fixed selling and administrative $1,200,000
- Variable selling $4 per unit
The component usually sells for $90 in the external market. The Adam Division is capable of producing 250,000 components per year; however, only 200,000 components are expected to be sold next year. The variable selling expenses are avoidable if the component is sold internally.
The West Division has been buying the same component from an external supplier for $80 each. The West Division expects to use 40,000 units of the component next year. The manager of the West Division has offered to buy 40,000 units from the Adam Division for $56 each.
Required:
1. Compute the effect on firm-wide income if 40,000 components are transferred internally at $56 each instead of purchased from an external supplier at $80 per unit.