Question

Twyla Company is a multidivisional company. Its managers have full responsibility for profits and complete autonomy to accept or reject transfers from other divisions. Division A produces a subassembly part for which there is a competitive market. Division B currently uses this subassembly for a final product that is sold outside at $2,400. Division A charges Division B market price for the part, which is $1,500 per unit. Variable costs are $1,100 and $1,200 for Divisions A and B, respectively.

The manager of Division B feels that Division A should transfer the part at a lower price than market because at market, Division B is unable to make a profit.

(a)

Calculate Division B’s contribution margin if transfers are made at the market price, and calculate the company’s total contribution margin. (Enter negative amounts use either a negative sign preceding the number eg -45 or parentheses eg (45).)

Division B's contribution margin		$
Company’s total contribution margin		$

(b)

Assume that Division A can sell all its production in the open market. Should Division A transfer the goods to Division B?

NoYes

(c)

Assume that Division A can sell in the open market only 500 units at $1,500 per unit out of the 1,000 units that it can produce every month. Assume also that a 20% reduction in price is necessary to sell all 1,000 units each month.

Compute the contribution margins under following three different alternatives to support your decision. (Round answers to the nearest whole dollar, e.g. 5,275.)

Alternative 1:		Maintain price, no transfers		$
Alternative 2:		Cut price, no transfers		$
Alternative 3:		Maintain price and transfers		$

Should transfers be made?

NoYes

If so, how many units should the division transfer and at what price? (If no transfer is necessary input 0 units at $0.)

The division should tansfer

units at $

1,100 to 1,2001,200 to 1,2001,100 to 2,30001,200 to 1,5001,100 to 1,5001,200 to 2,3001,100 to 2,400

Answer 1

Part A Division A Division B Total Sales 1500 2400 2400 Less: costs Variable costs 1100 1200 2300 Transfer costs 1500 0 Total costs 1100 2700 2300 Contribution margin 400 -300 100

Part B In the given situation, no transfers would be executed as the transfers are based on the market prices less avoidable cost, if any. However, the opportunity cost is referred as the market price.

Part C Maintain price, no transfers (500*1500)-(500*1100) $2,00,000 Cut price, no transfers (1000*(1500*(1-20%)))-(1000*1100) $1,00,000 Maintain price and transfers (500*2400)+(500*1500)-((500*1100)+(500*1200)) $8,00,000

It is advantageous for the company to maintain the current market price for Division A’s product and transfer 500 units to Division B.

It is better to decide the transfer price within the range of $1100* to $1200** to encourage managers of both divisions to carry out transfers.

*Cost Incurred by Division A : Manager of Division A would like to recover at least cost incurred by Variable Cost incurred by it.

** $1,200 is the maximum cost that manager of Division B can pay for sub assembly part. It is the breakeven cost for Division B an cost incurred beyond $1,200 for subassembly part causes loss to Division B.