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Phoenix Inc., a cellular communication company, has multiple business units, organized as divisions. Each division’s management...

Phoenix Inc., a cellular communication company, has multiple business units, organized as divisions. Each division’s management is compensated based on the division’s operating income. Division A currently purchases cellular equipment from outside markets and uses it to produce communication systems. Division B produces similar cellular equipment that it sells to outside customers—but not to division A at this time. Division A’s manager approaches division B’s manager with a proposal to buy the equipment from division B. If it produces the cellular equipment that division A desires, division B will incur variable manufacturing costs of $60 per unit.

Relevant Information about Division B

Sells 95,000 units of equipment to outside customers at $130 per unit

Operating capacity is currently 80%; the division can operate at 100%

Variable manufacturing costs are $70 per unit

Variable marketing costs are $8 per unit

Fixed manufacturing costs are $940,000

Income per Unit for Division A (assuming parts purchased externally, not internally from division B)

Sales revenue $ 320
Manufacturing costs:
Cellular equipment 80
Other materials 10
Fixed costs 40
Total manufacturing costs 130
Gross margin 190
Marketing costs:
Variable 35
Fixed 15
Total marketing costs 50
Operating income per unit $ 140

Required:

1. Division A wants to buy 47,500 units from Division B at $75 per unit. Should Division B accept or reject the proposal to sell the 47,500 units? (a). Calculate the net operating profit or loss to Division B and to the firm as a whole if the 47,500 units are sold to Division A. (b.) Calculate the net benefit to the firm as a whole if Division A will accept a partial shipment from Division B.

2. What is the range of transfer prices over which the divisional managers might negotiate a final transfer price?

Solutions

Expert Solution

1. Division A wants to buy 47,500 units from Division B at $75 per unit. Should Division B accept or reject the proposal to sell the 47,500 units? (a). Calculate the net operating profit or loss to Division B and to the firm as a whole if the 47,500 units are sold to Division A. (b.) Calculate the net benefit to the firm as a whole if Division A will accept a partial shipment from Division B.

Existing Units sold = 95000

Capacity = 95000/80% = 118750

Incremental Contribution (118750-95000) * ($75 - $60)

$356250

Contribution lost (47500 – 23750)*($130-$70-$8-$15)

($878750)

Loss to Division B

($522500)

Division B should reject the proposal

(a) Calculation of Total Profit or Loss to the firm:

$

Profit (Loss) to Division B

($522500)

Profit to Division A = ($80 -$75) x 47500 units

$237500

Net Profit or (Loss) to the firm

($285000)

(b)

Calculation of Total Profit or Loss to the firm:

$

Profit to Division B [23750 * ($75 - $60) = $356250]

                        $356250

Profit to Division A = ($80 -$75) x 23750 units

$118750

Net Profit or Loss to the firm

                        $475000.00

2. What is the range of transfer prices over which the divisional managers might negotiate a final transfer price?

Range of transfer would be between the variable manufacturing cost for Division B manufacturing the units for division A i.e.$60 and market price at which the product is available for Division A in the outside market i.e. $80

ekkarill92 answered 2 years ago
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