Question

Tumi Sdn Bhd has two divisions: Pump Division and Washing Machine division. The Pump division produces pumps which it can sell its product to outside market and within the division. Pump Division has the capacity to manufacture 12,000 units of pumps each year but only 8,000 units can be sold to the outside market. This pump sells for RM15 per unit on the outside market. The Washing Machine division buys 4,000 units of pumps each year from Pump Division, and thus far has paid the market price. The outside supplier, Silky Bhd has recently offered to sell Washing Machine Division 4,000 units per year of the same part at the RM14 per unit, less a 10% discount.   The Pump Division could avoid RM1 per unit in variable costs on any sales to the Washing machine Division. Pump Division's costs relating to the product are:

Variable cost per unit RM10

Fixed costs (per year) (relevant range 0 to 14,000 units) RM30,000

Answer the following questions:

In a current situation:

What is the minimum price that Pump Division can offer to Washing Machine Division?

What is the maximum price that Pump Division can offer to Washing Machine Division?

If Washing Division requested Pump Division to sell to its division at RM8 per unit. Should Pump Division accept or reject the request? Explain your answer.

If Pump Division operates at full capacity and can sell the entire products. Calculate the minimum price that Pump Division can offer to Washing Machine Division.

Suppose that the Washing Machine Division buys the 4,000 units from the outside supplier at a price of RM14 per unit, less a 10% discount. Suppose that Pump Division has excess capacity of 4,000 units. As a result of Washing Machine Division shifting its purchases to the outside supplier, how would the yearly net operating income of Tumi Sdn. Bhd. be affected?

Answer 1

Req1. The Minimum price that Pump division can offer to Washing machine division is $ 9 per unit i.e. variable cost of manufacturing 4000 units to Pump Division as it is having an excess capacity to supply it ot another division.

Req2: The maximum price that can be charged from Washing machine division is $12.60 per unit (i.e. $14.00 less 10%) i.e. price at which it is available to washing machine division from outside market.

Req3: No Pump division should not accept the offer as it will lead to a loss of $1 per unit for PUmp Division as the cost of manufacturing is $9 per unit and it would receive only $8 per unit, resulting in loss of $1 per unit.

Req4: When the pump division does not have excess capacity then it can sell its output to another division at the sum of variable cost per unit and contribution lost per unit from the regular customer. Here, the variable cost of producing the units for Washin machine division is $9 per unit and contribution from regular customer is $5 per unit (i.e. $15-10) per unit. Therefore, the minimum price at which Pump division shall transfer is $14 per unit.

Req5: It will lead to loss of $14400 (i.e. 4000 units @3.60 per unit) to the company as a whole. When the excess capacity exist, then the units can be made at a cost of $9 per unit and it is made available from outside supplier at a cost of $12.60 per unit, resulting in an excess price paid $3.60 per unit. This results in a loss to a company of $3.60 per unit on 4000 units.