Question

Problem B Northern Co has recently opened a new division (Dishwasher Division). The new division needs a special pump as a component part of one of their dishwasher models. They can purchase these pumps from an outside supplier for $28 each. At their current volume, they need 200,000 pumps per year Northern Co.'s Pump Division also makes and sells these pumps. They have a capacity of 700,000 pumps per year and are currently selling 550,000 pumps to outside customers for $30 each Since they have some excess capacity, management of Northern Co is considering the possibility of having the new Dishwasher Division purchase their pumps from the Pump Division. The Pump Division would be able to avoid all variable selling costs on any sales to the Dishwasher Division. Capacity could not be increased. Both divisions are operated as profit centers. The Pump Division's cost per pump, based on their normal volume of 550,000 pumps per year: Variable costs: Direct materials 12.00 6.00 4.00 2.00 Total variable cost 24.00 Direct labor MOH Selling 4. By how much would Northern Co. be better or worse off (overall) if the pumps needed by the Dishwasher Division are made by the Pump Division? 5. What's the maximum price the Dishwasher Division would want to pay the Pump Division? 6. What's the minimum price the Pump Division would want to charge the Dishwashwasher Division? 7. Which transfer price would the management of Northern Co prefer? The maximum price as determined by the Dishwasher Division The minimum price as determined by the Pump Division The management of Northern Co should not care either way.

Answer 1

4.Savings in buying from Pump Division = ($28- 12-6-4)*200,000 = $1,200,000

Less: Contribution Margin lost from regular sales on 50,000 pumps = (30-24)*50,000 = $300,000

Hence, net benefit = $900,000

Northern Co. Would be better off by $900,000

Note: Since selling cost is not incurred on transfer, it is not taken in the costs

5.The maximum price dishwasher division would like to pay is equal to the price it is paying to the outside supplier = $28

6.Minimum Price pump division would like to charge = cost incurred + contribution margin lost

= (12+6+4)*200,000 + 6*50,000

= $4,700,000

I.e. $23.5 per unit

7.The answer is management should not care either way since as long as transfer takes place between division, the overall profits of the company will remain the same