Question

Gamma Division of Vaughn Corporation produces electric motors, 20% of which are sold to Vaughan's Omega Division and 80% to outside customers. Vaughn treats its divisions as profit centers and allows division managers to choose whether to sell to or buy from internal divisions. Corporate policy requires that all interdivisional sales and purchases be transferred at variable cost. Gamma Division's estimated sales and standard cost data for the year ended December 31, based on a capacity of 60,000 units, are as follows:
Omega
Outsiders

Sales
P 660,000

P5,760,000

Less: Variable costs
    660,000

2,640,000

Contribution margin
P    ----

P3,120,000

Less: Fixed costs
    175,000

     900,000

Operating income (loss)
P (175,000)

P2,220,000

Unit sales
     12,000
       48,000

Gamma has an opportunity to sell the 12,000 units shown above to an outside customer at P80 per unit. Omega can purchase the units it needs from an outside supplier for P92 each.

Required:
Assuming that Gamma desires to maximize operating income, how much is the Gamma Divisions’ operating income should it take on the new customer and discontinue sales to Omega?
Assume that Vaughn allows division managers to negotiate transfer prices. The managers agreed on a tentative price of P80 per unit, to be reduced by an equal sharing of the additional Gamma income that results from the sale to Omega of 12,000 motors at P80 per unit. On the basis of this information, compute the company's new transfer price.

Answer 1