Question

World ​Aeronautics, which sells​ aircraft, has two profit​ centers, Systems and Assembly. Systems makes navigation equipment and transfers them to​ Assembly, which then puts together the aircraft for external sale. Systems can make up to 200 units a year at a variable cost of ​$2 million each. Assembly has variable costs of $ 14 million per aircraft. Assembly receives an order for 6 planes for a price of ​$25 million each.

Suppose that Systems has no ability to sell its output externally and has excess capacity.
1.
Would the top management of World want the divisions to take the​ order?
2.
What range of transfer prices would induce the managers of Systems and Assembly to take the decision you identified in requirement​ 1?
Now suppose that Systems can sell any navigation systems it makes externally for ​$4 million per unit. The division incurs advertising and distribution costs of  $ 270 comma 000 per system for its external sales.
3.
Would the top management of World want the divisions to take the​ order?
4.
What range of transfer prices would induce the managers of Systems and Assembly to take the decision you identified in requirement​ 3?

World ​Aeronautics, which sells​ aircraft, has two profit​ centers, Systems and Assembly. Systems makes navigation equipment and transfers them to​ Assembly, which then puts together the aircraft for external sale. Systems can make up to 200 units a year at a variable cost of ​$2 million each. Assembly has variable costs of $ 14 million per aircraft. Assembly receives an order for 6 planes for a price of ​$25 million each.

Requirement 1. Suppose that Systems has no ability to sell its output externally and has excess capacity. Would the top management of World want the divisions to take the​ order? ​(Enter amounts in​ millions, $X.XX.)
- For World, each aircraft sold externally generates a positive contribution margin of ______ million. Since there are no capacity constraints, world ____ want the managers to take this order.

Requirement 3. Now suppose that Systems can sell any navigation systems it makes externally for ​$4 million per unit. The division incurs advertising and distribution costs of  $ 370 comma 000 per system for its external sales. Would the top management of Platinum want the divisions to take the​ order? ​(Round intermediary and final calculations to three decimal places. Enter the amounts in​ millions, $X.XXX.)

- For the systems division, the manager will not accept any price lower than _____ million

- For the assembly division, the manager will not a pay a transfer price higher than ____ million.

Requirement 3. Now suppose that Systems can sell any navigation systems it makes externally for ​$4 million per unit. The division incurs advertising and distribution costs of  $ 370 comma 000 per system for its external sales. Would the top management of Platinum want the divisions to take the​ order? ​(Round intermediary and final calculations to three decimal places. Enter the amounts in​ millions, $X.XXX.)

- A navigation unit sold directly to the external market generates a profit for platinum of $ ___ million. Top management would want the divisions to accept the order

Requirement 4. What range of transfer prices would induce the managers of Systems and Assembly to take the decision you identified in requirement​ 3? ​(Round intermediary and final calculations to three decimal places. Enter the amounts in​ millions, $X.XXX.)

- For the Systems division, the manager will not accept any price lower than $____ million

- For the Assembly division, the manager will not pay a transfer price higher than $_____ million.

Answer 1

1. Yes , the order will be accepted. Because the variable costs for Assembly is 14 millions and the sales price is 25 millions, resulting in a contribution of 11 million. The Systems division will be able to recover its variable costs from Assembly division by selling the products to them since there are no external customers.
2. The systems division will try to recover the variable and the fixed costs from assembly division, but since the division is not able to make external sales there is no margin lost, it will sell the units at the variable costs of 2 million each.

The assembly division also will not be willing to pay anything more than the price at which the products are available at market, since systems has excess capacity and not ability to sell its product externally, the assembly division will buy its product at the variable cost of systems.

3.If the systems division is able to make external sales, then contribution for the division will be (4 - 2- .27) = 1.73 million. Still the management of world would accept the sales of 6 planes, because the total margin of both unit combined will remain the same at 14 millions.

The systems division will have a profit of 1.73 and the assembly division will have a profit of 12.27 millions

4. The systems division will not accept a price lower than 3.73 millions( 4-2-.27) being the contribution lost has to be recovered from assembly division and the assembly division will not accept a price higher than 4 million being the external sales price for Systems division.