Question

Oxford Company has two divisions. Thames Division, which has an investment base of $81,900,000, produces and sells 1,000,000 units of a product at a market price of $150 per unit. Its variable costs total $47 per unit. The division also charges each unit $70 of fixed costs based on a capacity of 1,050,000 units.

Lakes Division wants to purchase 300,000 units from Thames. However, it is willing to pay only $144 per unit because it has an opportunity to accept a special order at a reduced price. The order is economically justifiable only if Lakes can acquire Thames’ output at a reduced price.

Required:

a. What is the ROI for Thames without the transfer to Lakes? (Round your answer to 2 decimal places.)

b. What is Thames’ ROI if it transfers 300,000 units to Lakes at $144 each? (Note: Assuming division Thames operates at capacity and adjusts regular sales to accommodate transfer of units to Lakes) (Round your answer to 2 decimal places.)

c. What is the minimum transfer price for the 300,000-unit order that Thames would accept if it were willing to maintain the same ROI with the transfer as it would accept by selling its 1,000,000 units to the outside market? (Note: Assuming division Thames operates at capacity and adjusts regular sales to accommodate transfer of units to Lakes) (Round your answer to 2 decimal places.)

Answer 1

Requirement 1:

Sales Revenue (1,000,000 units @ $150)	$ 150,000,000.00
Less: Variable Cost (1,000,000 units @ $47)	$ 47,000,000.00
Contribution Margin	$ 103,000,000.00
Less: Fixed Cost (1,050,000 units @ $70)	$ 73,500,000.00
Net Income	$ 29,500,000.00
Investment Base	$ 81,900,000.00
ROI	36.02%

Requirement 2:

Sales Revenue:
Market Sales (750,000 units @ $150)	$ 112,500,000.00
Internal Transfer (300,000 units @ $144)	$ 43,200,000.00
Total Sales Revenue	$ 155,700,000.00
Less: Variable Cost (1,050,000 units @ $47)	$ 49,350,000.00
Contribution Margin	$ 106,350,000.00
Less: Fixed Cost (1,050,000 units @ $70)	$ 73,500,000.00
Net Income	$ 32,850,000.00
Investment Base	$ 81,900,000.00
ROI	40.11%

Requirement 3:

Reduction inTransfer price = Change in Net Income / Number of Units

= ($32,850,000 - $29,500,000) / 300,000 units

= $3,350,000 / 300,000 units

= $11.17

Minimum transfer price = Current transfer price - Reduction in Transfer Price

= $144 - $11.17

= $132.83