Question

The American Battery Company has two divisions, the Electrical Division and the Assembly Division. Both divisions have the full authority to make purchasing and selling decisions of their division output to both outsiders and the other division. (A highly decentralized structure) Each Division operates as a separate profit center and is being evaluated on the basis of the divisionʹs reported profit. The Electrical Division makes the battery cores (inside components) of the battery, and the Assembly Division places those cores in a decorative customized casing to sell to customers. The Electrical Division capacity is 350,000 cores which are sold to both outside parties and the Assembly Division. They can sell the core to outsiders for $150 per unit. The production costs per battery incurred by the Electrical Division are as follows:
Direct materials $ 40
Direct manufacturing labor 30
Variable factory overhead 12
Fixed factory overhead 40
Total $122
The Assembly Division can buy the cores from an outside source for $145. The division adds $25 of incremental costs, and then sells the assembled battery for $190.

QUESTION:

Assuming there is sufficient capacity with the Electrical Division to produce and sell 100,000 cores to the Assembly Division and the transfer price has been negotiated to be $125, what would be the effect on company profits?
A) $7,800,000 increase in profits
B) $3,800,000 increase in profits.
C) $1,500,000 increase in profits
D) $8,300,000 increase in profits

Answer 1