Question

1. Alex Ltd, has two divisions, a Parts Division and Marketing Division. Each division operates as a profit centre.   The Parts Division manufactures keyboards and is free to sell its product internally and externally. The Parts Division’s annual capacity is 45,000 units and its fixed cost is $720,000. Currently, sexternal sales represent 70% of the Parts Division’s production capacity. The selling price for a keyboard is $60, and the variable manufacturing cost is 60% of the selling price. Commissions is $ 5 per unit.

The Marketing Division is requesting a new specialty Keyboard to be used with a new game. Mr. Roberts, the manager of the Marketing Division, has obtained a quote of $70 from external suppliers. He has asked the Parts Division to provide a quote for 9,000 units. To make the speciality order, the Parts Division needs to invest in a stamping machine, costing $36,000. In addition, the speciality keyboard will incur additional $15 of variable cost for new features; however, it will reduce the regular variable cost by $3 of commission cost due to internal transfer. It takes 2 regular keyboards to make 1 specialty keyboard. The new keyboard can be sold for $90.

                Required:

1. Calculate the minimum transfer price for the speciality keyboard order.
2. Establish the range for the transfer price, if any, between the two divisions.
3. Should the Parts Division pursue this opportunity to sell the speciality keyboard internally?

Answer 1

a. The required demand is 9000 Special keyboards and as one special key board requires 2 normal key boards's capacity. so total requirements is equivilant to 18000 normal key boards

Total capacity - 45000

70% of the sale is to outside so internal sale is 13500(45000*30%) . So if the parts division accepted the offer it will lose the opportunity to sell 4500 key boards outside.  

Outside Selling price per unit - 60 and contibution per unit is 19 ((60*40%)-5)

so total lost contribution for parts division if it accepts the offer is 85,500(4500*19)

This lost contribution is to be covered by 9000 units and so per unit contribution to be covered is 85500/9000 = 9.5

Relevant cost of the special key board :-

Normal variable expenses - 36

Additional feature expenses - 15

Additional equipment cost - 4 (36000/9000)

Less :-Saving in internal sale - 3

Total relevant cost 52 (36+15+4-3)

Add Lost contribution to be coverd 9.5

Sot toal minimum transfer price - $61.50 (52+9.5) -   

b) Transferor's (Parts division) minimum transfer price - 61.5 (As per above)

Transferee 's (Marketing division) maximum transfer price would be price which it can procure from outside ie 70.

So the range of the transfer price is $61.5 to $70

C) Part's division should pursue this opportunity as the exterrnal procument price is much higher than the the Part;s division minimum transfer price . So it can add a reasonable margin which will enable to maintain the Goal congruance of Alex Ltd at the same time will not affect the divisional profitability of the parts division