Question

Element Corporation has 2 divisions: The Cushion Division and the Chair Division. You are the Vice President in charge of the Cushion Division. Your Cushion Division is a profit center.

Each division has its own markets; that is, your Cushion Division sells cushions on the open market to outside customers at a price of $150 per cushion. The Chair Division makes chairs, and in connection with that, buys slightly cheaper quality cushions on the open market for $118 each. You happen to have excess capacity available in your Cushion Division.

Your accounting department has come up with the following unit costs associated with the production of one cushion:

Direct materials        $   15.00
Direct labor                      10.00
Variable overhead             8.00
Fixed overhead                12.00
Variable selling                   6.00
Fixed selling                        2.00
Variable administrative     4.00
Fixed administrative          3.00
           
               $   60.00

You have been approached by the Chair Division. They are in a very competitive market and are seeking to obtain cushions at a better price than the current $118 market price. Since you are all part of the same company, they figure that perhaps your Cushion Division can help.

Your accounting department has also figured out that there will be some cost savings should you produce cushions for the Chair Division. Specifically, variable selling will be reduced by 80%, variable administrative expenses will be cut by 50% while direct materials will be slashed by 30% because the cushion they use is of lesser quality than your normal one.

Your Cushion Division is a profit center. What does that mean? You have been given complete discretion in terms of negotiating a workable price at which to produce these cushions for the Chair Division.

What is minimum acceptable price that you would be willing to charge the Chair Division?

Let’s say you are now operating AT CAPACITY and are already selling all the cushions you can manufacture on the open market. Does this change anything? NOW what is the minimum price that you would be willing to charge? Why does this differ from your first answer?

Answer 1

Answer is given below