Better Banjos is a small manufacturing company located in Southern Arkansas. They specialize in producing high quality banjos (stringed musical instruments similar to violins, guitars, or fiddles) that are desired by blue grass music players all over the United States. Better Banjos is composed of two manufacturing departments that are both evaluated as profit centers. One manufacturing division produces strings and tuning pegs (little knob the tunes a string when turned). The other manufacturing division produces the wooden bodies from high quality mahogany and rosewood. After the strings and tuning pegs are produced in division A, they are shipped to Division B and are added to the wooden bodies to complete the banjos - the two plants are on the same facilities so the shipping charges are ignored. In addition to being used for the banjos produced in Division B, the strings and tuning pegs can also be used for guitars and other stringed instruments produced by other companies. In fact, about 33% of Division A's income comes from sales made to other companies. In the same sense that Division A is able to sell its product to other outlets than Division B, Division B is able to purchase strings and tuning pegs from other sources. Thus, each division is not 100% dependent upon the other division and instead, is capable of operating in some fashion in the absence of the other division. Division A's cost information is reported in the table below.
|
Cost Structure for Division A
|
|
Strings
|
|
|
|
|
|
Variable Costs
|
|
|
|
|
|
Labor
|
|
$1.20
|
|
|
|
Material &supplies
|
1.00
|
|
|
|
Fixed Costs
|
|
|
|
|
|
Equipment
|
0.75
|
|
|
|
Building
|
|
0.25
|
|
|
|
|
|
|
|
|
|
Pegs
|
|
|
|
|
|
Variable Costs
|
|
|
|
|
|
Labor
|
|
$0.50
|
|
|
|
Material & Supplies
|
3.50
|
|
|
|
|
|
|
|
|
|
Fixed Costs
|
|
|
|
|
|
Equipment
|
2.20
|
|
|
|
Building
|
|
0.40
|
|
|
Division B purchases the strings and tuning pegs from Division A for $3.50 per set of strings and $6.80 per set of tuning pegs. In addition to the cost of strings and tuning pegs, each banjo produced requires additional costs as described below:
|
Cost Structure for Division B
|
|
Variable Costs
|
|
|
|
|
|
Labor
|
|
$39.70
|
|
|
|
Material & Supplies
|
150.00
|
|
|
|
Fixed Costs
|
|
|
|
|
|
Equipment
|
5.00
|
|
|
|
Building
|
|
10.00
|
|
|
Division A currently sells 40,000 sets of strings to Division B for $3.50 and 20,000 sets of strings to other companies for $4.50. They also sell 40,000 sets of tuning pegs to Division B for $6.80 and 5,000 sets of tuning pegs to other companies for $12 each. Division A has excess capacity. Division B currently buys all their strings and tuning pegs from Division A, however, they have the ability to purchase all they need from an external vendor for $2.50 for strings and $7.00 for tuning pegs. Division A sells 40,000 banjos to its customers for $235 each.
After looking at the production and cost figures, the new division manager, Ima Boss, made the following remark:
"I've run some numbers and have concluded that Division A is holding back our profits by quite a lot. Based on my estimates, we can increase our division's profit by over 6% just by purchasing all of our strings from Sammy's Strings down on Main Street. He will sell them to us for $2.25 per set. If I pass on this deal and the plant supervisor finds out (the person in charge of both divisions), I'll be in trouble for sure!"
Please discuss a) whether you agree with Ima Boss and why or why not, b) what outcome will likely happen if Ima Boss decides to purchase strings from Sammy's Strings, c) any changes you think could be implemented to improve the situation overall, and d) any other points you would like to make. Be as comprehensive, clear, and concise as possible.