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. Required: 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 7 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?

Please give explanations.

Answer 1

1) Incremental Cost due divisional Transfer = increase in variable Cost

=155-140

=15

Incremental Cost saving due to Divisional Transfer = Decrease in selling Price

=180-170

= 10

Since the incremental saving from the divisional transfer is less then the cost it is advisable to buy the unit from the outside market. if the company transfer component between division the company overall profit will go down by 250000(50000*5).

2) Minimum transfer price = Variable cost + Contribution Lost

= 155 + (170-140)

= 155+30

=185

Since the minimum transfer price exceeds the market price. it will only benefit to the goal congruence if it purchases circuit from outside.

3)

New variable cost = 155-8

= 147

minimum divisional transfer price = Variable cost + contribution lost

= 147 +(170-140)

= 177

Since divisional transfer price is below the market value of circuit (180) it will be advisable to procure circuits from circuit division at a price between 177 and 180.

2) A) If it has spare capacity of 50000 units than,

Minimum divisional transfer price = variable cost

= 155

Since it is below the market price of the circuit(180) it is advisable to procure the circuit from the circuit division to maximize the overall profit of the company

B) for goal congruence the divisional transfer price should be   between 155 to 180 for goal congruence

3) If there is a special order of 50000 unit for 160

Minimum division transfer price = variable cost + contribution lost

= 155 +(160-140)

= 175

The market price of Circuit = 180

a)To maximize company-wide profit, should Satellite division be required to acquire the necessary components from Circuit division or from the external vendor it as the minimum divisional price is low and it will result in the increase in the profit of $250000

b)  transfer price Should be between 175 to 180 to induce the two divisional managers to make goal congruent decisions.

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