Question

Holmes and Watson are divisions of Doyle, Inc., operating as profit centers. Both are profitable. One of the products produced by Holmes is A62, which normally sells for $260/unit. Cost is $175/unit (60% variable). Watson is planning a new product, and is taking bids on one of the subassemblies. A62 would be appropriate for this subassembly. a) Discuss the factors Holmes should consider when submitting a bid. If Holmes does not submit the low bid, might Watson still benefit from accepting their bid? Discuss briefly.

Answer 1

1. The major issue here is for Holmes if acceptance would result in decline in return on investment and ultimately loss of profit.

If regular orders are not lost , the minimum acceptable transfer price for Holmes would be te variable cost plus direct costs of the modifications i.e. 175 X 60% = $ 105

If regular orders are lost due to acceptance of order, the contribution lost shall be added to above variable cost computed so as to arrive at acceptable minimum transfer price.

Other factors relevant for Holmes for decision making would be if Watson’s new product becomes a failure or if Holmes won’t be able to recoup the previous market share it held for A62.

2. If Holmes bid lower than the price quoted by outside suppliers, Watson would benefit from it.

It does not matter how much the Holmes bid. For Watson to benefit from it, the price quotation must be lower than what Watson is quoted from outside market.

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