Question

General Instrumentation Company manufactures dashboard instruments for heavy construction equipment. The firm is based in Baltimore, but operates several divisions in the United States, Canada, and Europe. The Hudson Bay Division manufactures complex electrical panels that are used in a variety of the firm’s instruments. There are two basic types of panels. The high-density panel (HDP) is capable of many functions and is used in the most sophisticated instruments, such as tachometers and pressure gauges. The low-density panel (LDP) is much simpler and is used in less-complicated instruments. Although there are minor differences among the different high-density panels, the basic manufacturing process and production costs are the same. The high-density panels require considerably more skilled labor than the low-density panels, but the unskilled labor needs are about the same. Moreover, the direct materials in the high-density panel run substantially more than the cost of materials in the low-density panels. Production costs are summarized as follows:

	LDP			HDP
Unskilled labor (0.80 hour @ $10)	$	8		$	8
Skilled labor:
LDP (0.25 hour @ $20)		5
HDP (1.00 hours @ $20)					20
Raw material		6			9
Purchased components		7			13
Variable overhead		8			16
Total variable cost	$	34		$	66

The annual fixed overhead in the Hudson Bay Division is $140,000. There is a limited supply of skilled labor available in the area, and the division must constrain its production to 44,000 hours of skilled labor each year. This has been a troublesome problem for Jacqueline Ducharme, the division manager. Ducharme has successfully increased demand for the LDP line to the point where it is essentially unlimited. Each LDP sells for $42. Business also has increased in recent years for the HDP, and Ducharme estimates the division could now sell anywhere up to 7,000 units per year at a price of $126.

On the other side of the Atlantic, General Instrumentation operates its Volkmar Tachometer Division in Berlin. A recent acquisition of General Instrumentation, the division was formerly a German company known as Volkmar Construction Instruments. The division’s main product is a sophisticated tachometer used in heavy-duty cranes, bulldozers, and backhoes. The instrument, designated as a TCH–320, has the following production costs.

TCH–320
Unskilled labor (0.80 hour @ $12)	$	9.60
Skilled labor (3 hours @ $18)		54.00
Raw material		12.40
Purchased components		170.00
Variable overhead		14.00
Total variable cost	$	260.00

The cost of purchased components includes a $160 control pack currently imported from an Asian electronics Company. Fixed overhead in the Volkmar Tachometer Division runs about $840,000 per year. Both skilled and unskilled labor are in abundant supply. The TCH–320 sells for $300.

Bertram Mueller, the division manager of the Volkmar Tachometer Division, recently attended a high-level corporate meeting in Baltimore. In a conversation with Jacqueline Ducharme, it was apparent that Hudson Bay’s high-density panel might be a viable substitute for the control pack currently imported from Japan and used in Volkmar’s TCH–320. Upon returning to Berlin, Mueller asked his chief engineer to look into the matter. Hans Schmidt obtained several HDP units from Hudson Bay, and a minor R&D project was mounted to determine if the HDP could replace the Japanese control pack. Several weeks later, the following conversation occurred in Mueller’s office:

Schmidt:	There’s no question that Hudson Bay’s HDP unit will work in our TCH–320. In fact, it could save us some money.
Mueller:	That’s good news. If we can buy our components within the company, we’ll help Baltimore’s bottom line without hurting ours. Also, it will look good to the brass at corporate if they see us working hard to integrate our division into General Instrumentation’s overall production program.
Schmidt:	I’ve also been worried about the reliability of supply of the control pack. I don’t like being dependent on such a critical supplier that way.
Mueller:	I agree. Let’s look at your figures on the HDP replacement.
Schmidt:	I got together with the controller’s people, and we worked up some numbers. If we replace the imported control pack with the HDP from Canada, we’ll avoid the $160 control pack cost we’re now incurring. In addition, I figure we’ll save $6.00 on the basic raw materials. There is one catch, though. The HDP will require some adjustments in order to use it in the TCH–320. We can make the adjustments here in Berlin. I’m guessing it will require an additional three hours of skilled labor to make the necessary modifications. I don’t think variable overhead would be any different. Then there is the cost of transporting the HDPs to Berlin. Let’s figure on $5.00 per unit.
Mueller:	Sounds good. I’ll give Jacqueline Ducharme a call and talk this over. We can use up to 12,000 of the HDP units per year given the demand for the TCH–320. I wonder what kind of a transfer price Hudson Bay will want.

Required:

1. 2-a. Compute the unit contribution margin of an LDP and an HDP.

2. 2-b. Compute the unit contribution margin of Volkmar's TCH-320 under each of its alternatives.

3. 2-c. What is the unit contribution to cover company's fixed cost and profit per hour of skilled labor (scarce resource) for the following.

4. 2-d. From the perspective of General Instrumentation’s top management, how many panels should be produced for each of the following purposes?

5. 3. Assume that Hudson Bay agrees to transfer 12,000 HDP units per year to Volkmar using a transfer price equal to its current selling price of $126. If Volkmar is able to get Hudson Bay to agree to a lower transfer price, what effect will this have on General Instrumentation's income?

6. 4. What is the minimum transfer price that the Hudson Bay Division would find acceptable for the HDP?

7. 5. What is the maximum transfer price that the Volkmar Tachometer Division would find acceptable for the HDP?

8. 6. From the perspective of the corporate controller for General Instrumentation, what transfer price range would you recommend the two divisions negotiate within for the HDP units?

Answer 1

2-a. Unit contribution margin of an LDP and an HDP.
Per unit	LDP	HDP
Selling price	42	126
Less: Variable costs:
Unskilled labor (0.80 hour @ $10)	8	8
Skilled labor:
LDP (0.25 hour @ $20)	5
HDP (1.00 hours @ $20)		20
Raw material	6	9
Purchased components	7	13
Variable overhead	8	16
Total variable cost	34	66
Contribution/unit (Selling price-Total Variable costs)	8	60

2-b.Unit contribution margin of Volkmar's TCH-320 under each of its alternatives	From outside	From Hudson Bay divn.
Selling price	300	300
Less: Variable costs:
Unskilled labor (0.80 hour @ $12)	9.6	9.6
Skilled labor (3 hours @ $18)	54	108	(54+(3hrs.*$18/hr.)
Raw material	12.4	6.4	12.4-6
Purchased components	170	136	170-160+126
Variable overhead	14	14
Transportation cost		5
Total variable cost	260	279
Contribution/unit (Selling price-Total Variable costs)	40	21

3.. Unit contribution margin of an LDP and an HDP.
Per unit	LDP	HDP	TCH
Selling price	42	126	300
Less: Variable costs:
Unskilled labor (0.80 hour @ $10)	8	8	9.6
Skilled labor:
LDP (0.25 hour @ $20)	5
HDP (1.00 hours @ $20)		20	108
Raw material	6	9	6.4
Purchased components	7	13	136	10+126
Variable overhead	8	16	14
Transportation cost			5
Total variable cost	34	66	279
Contribution/unit (Selling price-Total Variable costs)	8	60	21
2.d...Total units produced/sold/trfd.	128000	12000	12000
hrs.	32000	12000	12000
Total contribution	1024000	720000	252000	1996000
Fixed costs(140000+840000)				980000
Net income				1016000

4. Minimum transfer price that the Hudson Bay Division would find acceptable for the HDP

ie. Transfer Pricing When at Capacity(scarce skilled labor hrs.)

ie. Variable cost to produce 1 unit+Opportunity cost of selling internally

ie.66+(126-66)=

126

per unit

5.Maximum transfer price that the Volkmar Tachometer Division would find acceptable for the HDP

Outside purchase price+savings in raw material cost-Transportation cost

160+6-5=

161

per unit

6.From the perspective of the corporate controller for General Instrumentation, transfer price range would you recommend the two divisions negotiate within for the HDP units

Range should be between the maximum market price for the buying division --(ie. 160)   &

the minimum (variable+opportunity) cost to the selling division--(ie. 126)

so, the range is $ 126- $ 160