Question

Max Ltd. produces kitchen tools, and operates several divisions as investment centers. Division M produces a product that it sells to other companies for $16 per unit. It is currently operating at its full capacity of 45,000 units per year. Variable manufacturing cost is $9 per unit, and variable marketing cost is $3 per unit. The company wishes to create a new division, Division N, to produce an innovative new tool that requires the use of Division B's product (or one very similar). Division N will produce 30,000 units. Currently, Division N can purchase a product equivalent to Division M's from Company X for $15 per unit. However, Max Ltd. is considering transferring the necessary product from Division M.

1) Assume the transfer price is $12 per unit. How would this affect the purchasing costs of Division B.

3)How would this affect Max Ltd as a whole?
Affect on Division A? B? on Max Ltd?

Answer 1

1)	Total cost if purchased from outside = 30000*15 =	450000
	Total cost if purchased from Division M = 30000*12 =	360000
	Savings in purchase cost	90000
3)	Effect on Division M:
	Contribution margin if sold outside = 30000*(16-9-3) =	120000
	Contribution margin if transferred to Division N = 30000*(12-9) =	90000
	Loss of contribution margin	30000
	Effect on Max Ltd as a whole:
	Increase in net operating income of 90000-30000 =	60000
	Alternatively:
	Savings in variable marketing cost = 30000*3 =	90000
	Loss of sales revenue by not selling (by Division M)outside = 30000*16 =	480000
	Savings in not purchasing from outside for Division N = 30000*15 =	450000
	Increase in net operating income	60000