13–33
PROBLEM 13-49 (CONTINUED)
3. (a) The head of the German division should be a team player; however, when the
circuit board can be obtained locally for $465, it is difficult to get excited
about doing business with the U.S. operation. Courtesy of the shipping fee
(b) Yes. Delta will make $180.00 per circuit board ($72.00 + $108.00) if no transfer
takes place and all circuit boards are sold in the U.S.
U.S. operation:
Sales revenue……………………………………………….
$ 510.00
Less: Variable manufacturing cost……………………..
390.00
Income before tax…………………………………………..
$ 120.00
Less: Income tax expense ($120.00 x 40%)……………
48.00
Income after tax…………………………………………….
$ 72.00
German operation:
Sales revenue…………………………………..
$1,080.00
Less: Purchase price………………………….
$465.00
810.00
Income before tax………………………………
$ 270.00
Less: Income tax expense ($270.00 x 60%)..
162.00
Income after tax…………………………………
$ 108.00
4. When tax rates differ, companies should strive to generate less income in high tax–
Chapter 13 – Investment Centers and Transfer Pricing
13–34
SOLUTIONS TO CASES
CASE 13-50 (40 MINUTES)
1.
If New Age Industries continues to use return on investment as the sole measure of
division performance, Fun Times Entertainment Corporation (FTEC) would be reluctant
to acquire Recreational Leasing, Inc. (RLI), because the post-acquisition combined ROI
would decrease.
2.
Residual income is the profit earned that exceeds an amount charged for funds
committed to a business unit. The amount charged for funds is equal to an imputed
interest rate multiplied by the business unit’s invested capital.
13–35
CASE 13-50 (CONTINUED)
3.
a.
The likely effect on the behavior of division managers whose performance is
measured by return on investment includes incentives to do the following:
b.
The likely effect on the behavior of division managers whose performance is
measured by residual income includes incentives to do the following:
13–36
CASE 13-51 (50 MINUTES)
1. Diagram of scenario:
2.
First, compute the unit contribution margin of an LDP and an HDP as follows:
LDP
HDP
Price …………………………………………………………………………..
$28
$ 115
Less: Variable cost:
Unskilled labor …………………………………………………..
$5
$ 5
Skilled labor ………………………………………………………
5
30
Raw material ………………………………………………………
3
8
Purchased components …………………………..
5
15
Variable overhead ………………………………………………
GENERAL INSTRUMENTATION CORPORATION
Top Management
HUDSON BAY DIVISION
VOLKMAR TACHOMETER DIVISION
TCH-320
13–37
CASE 13-51 (CONTINUED)
Second, compute the unit contribution margin of Volkmar’s TCH-320 under each of its
alternatives, as follows:
TCH-320
Using
Imported
Control Pack
TCH-320
Using
an
HDP
Price …………………………………………………….
$275.00
$275.00
Less: Variable cost:
Unskilled labor …………………………….
$ 4.50
$ 4.50
Skilled labor ………………………………..
51.00
85.00
Raw material ……………………………….
10.50
Purchased components ……………….
Variable overhead ……………………….
12.00
12.00
Variable cost of manufacturing HDP
-0-
70.00
Variable cost of transporting HDP ..
Total variable cost ……………………….
Unit contribution margin ……………………….
$ 47.00
Hudson Bay’s “Three” Products
HDP for external sale
HDP for transfer
From the perspective of the entire company, the scarce resource that will limit overall
company profit is the limited skilled labor time available in the Hudson Bay Division. The
question, then, is how can the company as a whole best use the limited skilled labor time
available at Hudson Bay? The division has two products: LDP and HDP. One can view these
LDP
Chapter 13 – Investment Centers and Transfer Pricing
CASE 13-51 (CONTINUED)
What is the unit contribution to covering the overall company’s fixed cost and profit from
each of these three products? The calculations above show that the unit contribution
margin of an LDP is $6, and the unit contribution of an HDP sold externally is $45.
Moreover, the unit contribution to the overall company of an HDP produced for transfer is
$42, which is the increase in the unit contribution margin of the TCH-320 when it is
manufactured with the HDP instead of the imported control pack. To summarize:
Hudson Bay’s Product
Unit Contribution to
Covering the Company’s
Fixed Cost and Profit
HDP sold externally
HDP transferred internally
LDP
The analysis of these three products’ contribution margins (to General Instrumentation as a
whole) has not gone far enough, because the products do not require the same amount of
the scarce resource, skilled labor time. The important question is how much one hour of
limited skilled labor at Hudson Bay spent on each of the three products will contribute
toward the overall firm’s fixed cost and profit.
Hudson Bay’s Product
Unit Contribution
Margin
Skilled Labor per
Unit Required at
Hudson Bay
Contribution
Margin
per Hour
HDP sold externally
HDP transferred internally
LDP
13–39
CASE 13-51 (CONTINUED)
This analysis shows that from the perspective of the entire company, Hudson Bay’s best
use of its limited skilled labor resource is to produce HDPs for external sale, up to the
maximum demand of 6,000 units per year. The second best use of Hudson Bay’s limited
skilled labor is to produce HDPs for internal transfer, up to the maximum number of units
Skilled labor time available at Hudson Bay ………………………………
40,000
hours
(1)
Produce 6,000 HDPs for external sale
Hours remaining …………………………………………………………………….
hours
(2)
Produce 10,000 HDPs for internal transfer
Hours remaining …………………………………………………………………….
hours
Hours remaining …………………………………………………………………….
Division.
3.
Given that 10,000 HDPs are transferred, there is no effect on General Instrumentation
4.
Hudson Bay’s minimum acceptable transfer price is given by the general transfer-
pricing rule, as follows:
Minimum acceptable transfer price
=
=
$70 + $36
=
additional outlay
costs incurred
because goods
+
opportunity
cost to the
organization
Chapter 13 – Investment Centers and Transfer Pricing
13–40
CASE 13-51 (CONTINUED)
Explanatory notes:
(b)
The opportunity cost is equal to the forgone contribution margin on the LDP
units that Hudson Bay will be unable to produce because it is manufacturing an
5.
The maximum transfer price that the Volkmar Tachometer Division would find
acceptable is $112, computed as follows:
Savings if TCH-320 is produced using an HDP:
Imported control pack ………………………………………………………………….
$145.00
Other raw material ……………………………………………………………………….
5.50
Total savings ……………………………………………………………………………….
$150.50
Less: Incremental costs if TCH-320 is produced using an HDP:
Transportation cost ……………………………………………………….…………….
Skilled labor ………………………………………………………………………………..
Net savings if HDP is used ………………………………………………………………..
$112.00
If Volkmar’s management must pay $112 for an HDP, it will be indifferent between using
6.
The transfer is in the overall company’s best interest. Thus, any transfer price in the
13–41
CASE 13-52 (45 MINUTES)
1. Yes, Air Comfort Division should institute the 5% price reduction on its air
conditioner units because net income would increase by $264,000. Supporting
calculations follow:
Before 5%
Price Reduction
After 5%
Price Reduction
Per
Unit
Total
(in thousands)
Per
Unit
Total
(in thousands)
Total
Difference
(in thousands)
Sales revenue
$800
$12,000
$760
$13,224.0
$1,224.0
Variable costs:
Compressor
$140
$ 2,100
$140
$ 2,436.0
$ 336.0
Other direct material
Direct labor
Variable overhead
Variable selling
540
626.4
86.4
Total variable costs
$400
$ 6,000
$400
$ 6,960.0
$ 960.0
Contribution margin
$400
$ 6,000
$360
$ 6,264.0
$ 264.0
Summarized presentation:
Contribution margin of sales increase ($360 2,400) $864,000
2. No, the Compressor Division should not sell all 17,400 units to the Air Comfort
Division for $100 each. If the Compressor Division does sell all 17,400 units to Air
13–42
CASE 13-52 (CONTINUED)
Outside
Sales
Air Comfort
Sales
Selling price …………………………………………………………………………………..
$200
$100
Variable costs:
Direct material ………………………………………………………………………………
24
$ 21
Direct labor ………………………………………………………………………………….
16
Variable overhead ……………………………………………………….
20
Variable selling expenses ……………………………………………………….
Total variable costs ……………………………………………………….
$ 57
Capacity calculation in units:
Total capacity ………………………………………………………………………………..
75,000
Sales to Air Comfort ………………………………………………………………………
17,400
Balance ……………………………………………………………………………………..
57,600
Projected sales to outsiders …………………………………………………………..
64,000
Solution:
Contribution from sales to Air Comfort ($43 17,400) ……………………..
$748,200
3. Yes, it would be in the best interests of Continental Industries for the Compressor
Chapter 13 – Investment Centers and Transfer Pricing
13–43
CASE 13-52 (CONTINUED)
Cost savings by using compressor unit from Compressor Division:
Air Comfort Division’s outside purchase price ……………………………….
$ 140
Compressor Division’s variable cost to produce (see req. 2). …………
57
Savings per unit ……………………………………………………………………………
$ 83
x Number of units ……………………………………………………………………..
x 17,400
Total cost savings …………………………………………………………………………
$1,444,200
819,200
4. As the answers to requirements (2) and (3) show, $100 is not a goal-congruent