Question

Oxford Company has two divisions. Thames Division, which has an investment base of $80,800,000, produces and sells 950,000 units of a product at a market price of $145 per unit. Its variable costs total $44 per unit. The division also charges each unit $70 of fixed costs based on a capacity of 1,000,000 units.

Lakes Division wants to purchase 250,000 units from Thames. However, it is willing to pay only $138 per unit because it has an opportunity to accept a special order at a reduced price. The order is economically justifiable only if Lakes can acquire Thames’ output at a reduced price.

Required:

a. What is the ROI for Thames without the transfer to Lakes? (Round your answer to 2 decimal places.)

b. What is Thames’ ROI if it transfers 250,000 units to Lakes at $138 each? (Note: Assuming division Thames operates at capacity and adjusts regular sales to accommodate transfer of units to Lakes) (Round your answer to 2 decimal places.)

c. What is the minimum transfer price for the 250,000-unit order that Thames would accept if it were willing to maintain the same ROI with the transfer as it would accept by selling its 950,000 units to the outside market? (Note: Assuming division Thames operates at capacity and adjusts regular sales to accommodate transfer of units to Lakes) (Round your answer to 2 decimal places.)

Answer 1

Part a	Calculation of Return on Investment
	Thames Division
	sale of 950000 Units
	Sales Revenue (950000* $145)	$                        137,750,000.00
	Less: Variable Cost( 950000*$44)	$                           41,800,000.00
	Contribution Margin	$                           95,950,000.00
	Fixed Cost (1000000*$70)	$                           70,000,000.00
	(A) Net Income	$                           25,950,000.00
	(B) Total Investment	$                           80,800,000.00
	(A/B) Return on Investment	32%

Part b	Calculation of Return on Investment
	Thames Division
	Sale of 1000000 Units
	Sales Revenue ((750000* $145)+250000*$ 138)	$                        143,250,000.00
	Less: Variable Cost( 1000000*$44)	$                           44,000,000.00
	Contribution Margin	$                           99,250,000.00
	Fixed Cost (1000000*$70)	$                           70,000,000.00
	(A) Net Income	$                           29,250,000.00
	(B) Total Investment	$                           80,800,000.00
	(A/B) Return on Investment	36%

Part c	Calculation of Minimum Transfer price
	Target Income	$                           25,950,000.00

	Minimum price would be Variable cost plus loss of contribution on reduced market sales.
	Details	Per Unit	units
	Variable cost	$                                           44.00	250000	$ 11,000,000.00
	Contribution on 200000 units
	(145-44)	$                                         101.00	200000	$ 20,200,000.00
	Total Cost on Transfer			$ 31,200,000.00
	Total Transfer Units			$        250,000.00
	Minimum Transfer price			$                124.80

Note 1- Variable cost is taken for 250000 units as that would be recovered from lakes division.

Note 2- Contribution margin lost on sale of 200000 units would be recovered as 200000 units would have generated contribution if these are sold in market for $145 per Unit.

Note 3- Contribution lost on 200000 units is taken instead of 250000 because 50000 units are still left in the capacity.

Calculation of Return on Investment At transfer price $ 124.8
Thames Division
Sale of 1000000 Units
Sales Revenue ((750000* $145)+250000*$ 138)	$                        139,950,000.00
Less: Variable Cost( 1000000*$44)	$                           44,000,000.00
Contribution Margin	$                           95,950,000.00
Fixed Cost (1000000*$70)	$                           70,000,000.00
(A) Net Income	$                           25,950,000.00
(B) Total Investment	$                           80,800,000.00
(A/B) Return on Investment	32%