Would Diamond Limited benefit if Italy branch purchases from India branch? COMMENT.

Problem Definition: If Retail Gems buys from Division Ahmedabad, will it benefit the company as a whole? Key Considerations: Contribution p.u. under external and internal sale options and the tax impact. Methodology: Part 1: Benefit to Division Ahmedabad Currently external sales are 1,00,000 units. If Division Ahmedabad accepts to cater to Retail Gems's requirements, external sales have to be curtailed by 30,000 units. The sales mix would be external sales 70,000 units and internal transfer 50,000 units. (refer working note 1). Division Ahmedabad was previous producing 1,00,000 units. On accepting Retail Gems's order, it is operating at full capacity of 1,20,000 units, an additional 20,000 units are being produced. As per working note 2, contribution from each option is the same at 28,000 p.u. Additional Contribution = 20,000 units × ₹ 28,000 p.u. = 56,00,00,000 Division Ahmedabad pays tax in India at 30%. Hence, the Net Tax Contribution = 56,00,00,000 × (100% - 30%) = 39,20,00,000 Part 2: Net Additional Cost to Retail Gems Retail Gems is currently purchasing item similar to Gem-Milano within Italy at 1,44,000 p.u. (₹ equivalent value). If it purchases from Division Ahmedabad, it will pay - 9,000 p.u. extra. Additional Purchase Cost = 50,000 units × (₹ 1,53,000 -1,44,000) = 45,00,00,000 However, this extra cost is tax deductible at a rate of 40%, the tax rate in Italy. Hence Additional Cost (net of tax) = 45,00,00,000 × (100% - 40%) = 27,00,00,000 Part 3: Overall benefit (after tax) to the company Division Ahmedabad benefits by - 39,20,00,000 while Retail Gems incurs an extra cost of 27,00,00,000. Hence, the net after tax benefit to the company is 12,20,00,000. Therefore, Retail Gems should purchase Gem-Milano internally from Division Ahmedabad. Working Notes 1. Statement of Capacity Utilization of Division Ahmedabad Sr. No. Particulars Number of units 1 Maximum Capacity 1,20,000 2 External Sales 1,00,000 3 = 1-2 Spare Capacity 20,000 4 Retail Gems's Requirement 50,000 5 = 4-3 External Sales Curtailed to meet Retail Gems 's Demand = Retail Gems 's Requirement - Spare Capacity Available = 50,000 units - 20,000 units 30,000 From the above table it can be seen that Division Ahmedabad has a spare capacity of 20,000 units currently. However, if it has to cater to Retail Gems's requirements, external sales have to be curtailed by 30,000 units. 2. Statement of Contribution p.u. Sr. No. Options External Sale Internal Sale 1 Selling Price p.u. 1,08,000 1,26,000 2 Variable Cost p.u. 80,000 74,000 3 Modification Cost p.u. --- 24,000 4 = 1-2-3 Contribution p.u. 28,000 28,000