Question

Part 2B

Cooking Company has a decentralized organization with a divisional structure. Two of these divisions are the Appliance Division and the Housing Division. Each divisional manager is evaluated on the basis of ROI. The company uses the opportunity cost approach to make sure there is goal congruence. The Appliance Division produces a small automatic dishwasher the Housing Division can use in one of its models.

The appliance division can produce up to 20,000 of these dishwashers per year. The variable costs of manufacturing the dishwashers are $98 The Housing Division inserts the dishwasher into the model house and then sells the house.

Needed

1. Assume that all the dishwashers produced can be sold to external customers for $320 each. The Housing Division wants to buy 4,000 dishwashers per year. What should be the transfer price? Why?

2. Refer to requirement #1 above. Assume there are $24 avoidable distribution costs that will not be incurred if the company sells internally.

A. Identify the minimum transfer price.

B. Identify the maximum transfer price.

C. Identify the actual price, assuming that negotiation splits the difference.

3. Assume that the Appliance Division is producing and selling 75% capacity. The Housing Division is currently buying 4,000 dishwashers from an outside supplier at $290 each

Assume that any joint benefit will be split evenly between the two divisions.

A. What is the expected transfer price based on this information in #3?

B. How much with the profits of the Appliance Division increase, assuming that it sells the extra 4,000 dishwashers internally?

C. How much with the profits of Housing Division increase, assuming that it buys the 4,000 dishwashers internally?

D. How much will the profits of the firm increase under this arrangement in #3?

Answer 1

1.Transfer price should be equal to market price per unit as it represents opportunity cost

i.e. $320 per unit

i.e. 320*4000 = $1,280,000

2.A.Minimum Price = Market Price – Avoidable cost

= 320-24

= $296 per unit

B.Maximum price = Market price

= $320 per unit

C.Actual Price = 296+12 = $308 per unit

3.Relevant cost is variable cost since there is spare capacity

Price = 98 + (290-98)/2 = $194 per unit

B.Increase in profits of Appliance Division = 4000*(194-98) = $384,000

C.Housing Division = (290-194)*4000 = $384,000

D.Firm = $768,000