Question

Wood Inc. manufactures wood poles. Wood has two responsibility centres, harvesting and sawing, which are both evaluated as profit centres. The harvesting division does all the harvesting operations and transfers logs to the sawing division, which converts the wood into poles for external clients. When operating at full capacity, the sawing division can convert 13,400 poles. Management is considering replacing this type of wood pole with another type of wood pole that can be sold at a lower price and could allow the firm to operate at full capacity all the time.

The director of the sawing division suggested that the maximum price the division can pay for each log from harvesting is $27.50. Following is the information that supports this suggestion:

Price per pole that the client would pay				$90
Direct labour costs		$35.00
Variable overhead costs		4.30
Fixed overhead costs		8.80
Raw material costs (other than logs)		2.40
		50.50
Profit margin		12.00
Total costs and profit margin				62.50
Maximum price for a log				$27.50

The director of the harvesting division disagrees with selling the logs at a price of $27.50. The division is operating at full capacity and sells logs to external clients for $45.00. Moreover, the director says, “My direct labour costs are $21.00, my variable overhead costs are $4.50, and my fixed overhead costs are $9.10. I can’t cut trees for $34.60 and sell them for $27.50.”

(a)

Assuming production is at full capacity, determine whether Wood Inc., as a whole, would make a higher profit if logs were transferred to the sawing division for $27.50 per log.

Contribution margin from selling logs		$
Contribution margin from selling poles		$
It would be beneficial/ not beneficial for Wood Inc, to transfer the logs at $27.50.

Answer 1

	Answer
	Explanation :
a)	Contribution margin from selling 13,400 logs = (45 - (21 + 4.50) * 13,400
	= $261,300
b)	Contribution margin from selling 13,400 poles
	= (90-(21+4.5)-(35+4.3+2.4))*13400
	= (90 - (25.50) - (41.70)) * 13,400
	=   $305,520
	The net increase in contribution margin = $305,520 - $261,300 = $44,220
	Therefore, it would be beneficial for Wood Inc., to transfer the logs at $ 27.50