Question

Walker Inc. has two divisions, Circuit and Satellite, both located in the United States. The Circuit division produces an electronic component, circuit no. 222, which is sold to external customers. The variable production cost for circuit 222 is $140. The division has the capacity to manufacture 100,000 of this circuit each year. The fixed cost of production is $20 per unit (unitized at the full capacity of 100,000 units).

Recently, the Satellite division of the company has expressed interest in procuring 50,000 units of a slightly modified version of circuit 222. The Satellite division plans to use this component in manufacturing a global positioning system. While the production capacity and fixed costs of Circuit division would remain unchanged, the required modification would increase its variable cost of production to $155 per unit. The Satellite system can procure a comparable component from an external vendor for a price of $180 per unit.

1) Assume that Circuit division can sell up to 100,000 units of circuit 222 in the external market for $170/unit.

(a) To maximize company-wide profits, should the Satellite division be required to acquire the necessary part from Circuit division or from the external vendor? Support your answer with calculations.

(b) What transfer price would induce the two divisional managers to make goal congruent decisions?

(c) Assume now that the Circuit division is at full capacity and can sell its output at $170 per unit in the open market. Circuit division can outsource a component of the part that Satellite division needs and this will lower the variable cost of production of the satellite division circuit board by $8 per unit. Should Circuit division make the circuit board for the Satellite division and what will be the transfer price?

2) Now assume that Circuit division can sell only 50,000 units of circuit 222 in the external market for $170/unit.

(a) To maximize company-wide profits, should Satellite division be required to acquire the necessary components from Circuit division or from the external vendor? Support your answer with calculations.

(b) What transfer price would induce the two divisional managers to make goal congruent decisions?

3) Now assume that Circuit division can only sell 50,000 units of circuit 222 in the external market for $170/unit. However, Circuit division is currently considering a special one-time order from a Mexican company which is willing to pay $160 per unit for additional 50,000 units.

(a) To maximize company-wide profit, should Satellite division be required to acquire the necessary components from Circuit division or from the external vendor? Support your answer with calculations.

(b) What transfer price would induce the two divisional managers to make goal congruent decisions?

Answer 1

Solution 1-a	Capacity utilized @ 100,000 units
	Since Circuit division is able to sell all its output in market, Circuit division will make sure that any divisional transfer provides it the same contribution
	as provided by external customers
		Circuit division
	Variable cost	$            155.00
	Contribution (170-140)	$              30.00
	Minimum transfer price	$            185.00
	Price available to satellite dvision	$            180.00
	Company as a whole, the transfer should not be effected.
Solution 1-b
	Since the maximum and minimum price between 2 entities are not same, goal congruent decision will be to purchase from outside vendor.
Solution 1-C
		Circuit division
	Variable cost	$            155.00
	Variable cost reduced by outsourcing some part	$               (8.00)
	Contribution (170-140)	$              30.00
	Minimum transfer price	$            177.00
	Price available to satellite dvision	$            180.00
	In this case, Circuit division should supply the requisite units to Satellite division @ $ 177
Solution 2-a
	Capacity utilized @ 50,000 units
	Since Circuity division is able to sell only 50,000 units of its output in market, they can supply (100,000-50,000 = 50,000) unit at variable cost so that no loss is happening
		Circuit division
	Variable cost	$            155.00
	Minimum transfer price	$            155.00
	Price available to satellite dvision	$            180.00
	Company as a whole, the transfer should be effected and Satellite department should purchase from Circuit division @ 155.
Solution 2-b
	Any price between $ 155 to $ 180 will result into higher profits for 2 divisions.
Solution 3-a
	Capacity utilized @ 50,000 units
	Additional capacity also utilized @ 50,000 units at $ 160.
		Circuit division
	Variable cost	$            155.00
	Contribution from additional units (160-140)	$              20.00
	Minimum transfer price	$            175.00
	Price available to satellite dvision	$            180.00
	Company as a whole, the transfer should be effected and Satellite department should purchase from Circuit division @ 175.
Solution 3-b
	Any price between $ 175 to $ 180 will result into higher profits for 2 divisions.