Plato Co. ltd has two divisions -D1 and @-D. Division D1 operates at 100% capacity level has been required by the company management to supply its product to Division D-2 which is at present operational at 60% capacity. Division D-2 needs the productproduced by division D-1 for supplementing its main product and is willing to pay Shs. 200 per unit against Shs. 300 per unit which D-1 can charge to external customers. D-1 ‘s full cost per unit is Shs. 200 whereas its variable cost is shs 170 per unit. D-2’s cost per unit after purchase from D-1 is Shs 2000 with the following beak up:
| Parts purchased from outside vendor | 900 |
| Parts purchased from D-1 | 200 |
| Other variable cost | 400 |
| Fixed cost (per unit) | 400 |
| D-2 can fix selling price per unit full cost plus 10% |
Required:
You are the manager of division D-1. Would you recommend sales to D-2? Use computation to justify your decision.
In the world of business operations, decision-making is a complex task that requires careful consideration of various factors, ranging from costs and capacities to strategic alignment and profitability. In the scenario presented, we will delve into the decision-making process concerning whether Division D1 should supply its product to Division D2 within Plato Co. Ltd. This analysis aims to optimize the financial performance of both divisions and the overall company.
Plato Co. Ltd consists of two divisions: D1 and D2. Division D1 is operating at full capacity while Division D2 is functioning at 60% capacity. Division D2 needs to source its product from Division D1 and is willing to pay Shs. 200 per unit for the product. Division D1 can sell the same product to external customers for Shs. 300 per unit. Division D1’s full cost per unit is Shs. 200, with a variable cost of Shs. 170 per unit.
Division D2’s cost per unit, after purchasing from Division D1, is Shs. 2000, with a breakdown as follows:
Parts purchased from outside vendor: Shs. 900
Parts purchased from Division D1: Shs. 200
Other variable costs: Shs. 400
Fixed costs (per unit): Shs. 400
D2 can set its selling price per unit at full cost plus 10%.
Before making a recommendation, it’s crucial to assess the financial implications of this arrangement. Let’s break down the costs and potential revenues involved:
Supplying to D2
Selling price to D2: Shs. 200
Variable cost per unit for D1: Shs. 170
Contribution per unit: Shs. 30 (Selling Price – Variable Cost)
External Sales
Selling price to external customers: Shs. 300
Variable cost per unit for D1: Shs. 170
Contribution per unit: Shs. 130 (Selling Price – Variable Cost)
Considering the cost analysis, the decision whether to supply to Division D2 or focus on external sales hinges on maximizing profitability for Division D1 and, consequently, for Plato Co. Ltd.
With a contribution of Shs. 130 per unit from external sales as opposed to Shs. 30 per unit from supplying to Division D2, it’s evident that supplying to external customers is the more profitable option for Division D1. By selling externally, Division D1 generates a significantly higher contribution margin, which contributes to covering fixed costs and increasing overall profits.
In light of the comprehensive analysis conducted, it is recommended that Division D1 should prioritize selling its product to external customers rather than supplying Division D2. This decision will help Division D1 achieve a higher contribution margin per unit and contribute more effectively to the profitability of Plato Co. Ltd as a whole. By optimizing its resource allocation and focusing on activities that yield greater profitability, Plato Co. Ltd can strengthen its financial position and continue to drive success in the competitive business landscape.
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