Question

Phoenix Inc., a cellular communication company, has multiple business units, organized as divisions. Each division’s management is compensated based on the division’s operating income. Division A currently purchases cellular equipment from outside markets and uses it to produce communication systems. Division B produces similar cellular equipment that it sells to outside customers—but not to division A at this time. Division A’s manager approaches division B’s manager with a proposal to buy the equipment from division B. If it produces the cellular equipment that division A desires, division B will incur variable manufacturing costs of $60 per unit.

Relevant Information about Division B

Sells 80,000 units of equipment to outside customers at $130 per unit

Operating capacity is currently 80%; the division can operate at 100%

Variable manufacturing costs are $70 per unit

Variable marketing costs are $8 per unit

Fixed manufacturing costs are $820,000

Income per Unit for Division A (assuming parts purchased externally, not internally from division B)

     

Sales revenue				$	320
Manufacturing costs:
Cellular equipment		80
Other materials		10
Fixed costs		40
Total manufacturing costs					130
Gross margin					190
Marketing costs:
Variable		35
Fixed		15
Total marketing costs					50
Operating income per unit				$	140

Required:

1. Division A wants to buy 37,000 units from division B at $75 per unit. Determine the contribution margin for each type sale by division B. Should division B accept or reject the proposal? How would your answer differ if (a) division A requires all 37,000 units in the order to be shipped by the same supplier and what would be the net operating loss or gain to division B and the firm as a whole, or (b) division A would accept partial shipment from division B and what would be the benefit from this alternative to division B?

2. What is the range of transfer prices over which the divisional managers might negotiate a final transfer price?

How would your answer differ if division A would accept partial shipment from division B and what would be the benefit from this alternative to division B?

	Total capacity of division B ????? Maximum sales possible to outside consumers ????? Remaining Capacity ????? Contribution per unit ???? Total Contribution or benefit from this alternative ????

Please help!

Answer 1

Answer is given below

Division B Operating capacity Operating capacity % Total capacity 80,000 80% 100,000 Excess Capacity 20,000 If Division A wants 37,000 units sales to existing customers will reduce by 17,000 units Contribution for sale to Division A Units sold 37,000 Contribution per unit $15 ($75-$60) Total Contribution $555,000 A Units Contribution lost for not selling to existing customers 17,000 Contribution per unit $52 ($130- $70 - $8) Total contribution lost $884,000 B Net Loss -$329,000 A-B Since is there is Net loss sales should not be made to Division A $20 Firm savings Division A savings buying inside Savings per unit ($80-$60) Units 37,000 Total savings $740,000 A Division B Opportunity loss (17,000 X $52) Net Loss to the firm $884,000 B -$144,000 A-B b) If Partial units are accepted by Division A Then units above normal capacity should be sold 20,000 Excess units Contribution per unit Incremental contribution $15 $300,000 Sales to External customer will 80,000 units hence no loss of contribution 2 Range of transfer price Assuming external sales is foregone Division B Variable cost $60 Opportunity cost $52 ($130-$70 - $8) Maximum Transfer price $112 When external sales is forgone golden rule for transfer pricing is Variable cost + Opportunity cost (Contribution foregone) External market price $80 Divisions B should be accepting minimum price of $112 if it is forgoing external sales Division A should be accepting maximum price of $ 80 since it is external buying price If partial shipment of 17,000 units can be accepted it should be transferred internally only as there is excess capacity with Division B Total capacity Maximum external sales Remaining capacity contribution per unit Total Contribution 100,000 80,000 20,000 $15 $300,000