Question

The Scissor Brothers Corp. produces and sells scissors (of course). Scissors Bros. is organized into two divisions, the UP division and the DOWN division. The UP division manufactures 30,000 pairs of scissors per year, selling 10,000 units externally at a price of $8 each and transferring the remaining 20,000 units internally to the DOWN division. The DOWN division modifies these 20,000 units and sells them to external clients. The UP division incurs variable manufacturing costs of $4.50 for each of its 30,000 output units and total annual fixed manufacturing cost of $60,000. You can ignore SG&A costs for this exercise.
Scissor Brothers have adopted a market-based transfer pricing policy. For each pair of scissors it receives from the UP division, the DOWN division pays the weighted average external price the UP division charges its customers outside Scissor Brothers. The current transfer price thus equals $8.
Ana Patronic, the manager of the UP division receives an offer from Jean-Georges, an international hair salon supplier. Jean-Georges offers to buy 4,000 pairs of scissors at a price of $6.30 each, knowing that the entire scissors industry (including Scissor Brothers) has excess capacity at this time. There are no additional fixed manufacturing, SG&A, or transportation costs associated with this offer. UP’s variable manufacturing costs are $4.50 also for each of the units Jean-Georges is requesting. Accepting Jean-Georges’ offer would not affect the current price of $8 charged to existing external customers.
Question 1:
a. What is the “contribution margin” associated with this special order from Jean-George. What is the appropriate interpretation of this number? (Note: Recall from your Cost Accounting Class that contribution margin is the revenue you generate minus all variable costs.

b. Compute the resulting change in the UP division’s profit if they accept Jean-Georges’ offer. Will Ana Patronic accept this offer if she aims to maximize the UP division’s profit?
c. Would the top management of Scissor Brothers Corp. want the UP division to accept the offer? Compute the change in firm-wide profit associated with Jean-Georges’ offer.

Answer 1

Requirement a
	Contribution margin associated with this special order fromJean-George
	Units   =	4000	Total Amount	Per unit
	Sales Revenue		25200	6.3
	Variable costs		18000	4.5
	Contribution margin		7200
	Interpretation implies that any revenue received above the variable costs
	is a pure operating profit given that fixed expenses are constant and business
	is already doing profit.
Requirement b
	Existing profit made by UP Division
	Units   =	30000	Total Amount	Per unit
	Sales Revenue		240000	8
	Variable costs		135000	4.5
	Contribution margin	A	105000
	Revised profit made by UP division
	Units   =	34000	Total Amount	Per unit
	Transfer to Down division	20000	150286	7.514
	Sales Revenue to external customers	10000	80000	8
	Sales Revenue for Jean-Geroge	4000	25200	6.3
	Total sales		255486
	Variable costs		153000	4.5
	Contribution margin	B	102486
	Profit of UP division is decreased by
		A-B	2514
	If Ana Patronic wants to maximize the UP division's profit, she
	should not accept the offer.
	Working Note :
	Weighted average price		=(4000*6.3+10000*8)/14000
			7.51428571
Requirement c
	Yes, Top management would definitely want UP division to accept
	the offer as firm-wide profit will increase by			7200
	Since , it will not affect the existing price of scissors to external
	customers and there is not any change in demand for scissors
	due to this order, Anything received above the variable cost from
	new order is incremental revenu(profit) for the firm.