PROBLEM

Ecological Products Corporation

The Electric Division of Ecological Products Co. has developed a wind generator that requires a
special "S" ball bearing. The Ball Bearing Division of Ecological Products Co. has the capability to
produce such a ball bearing.

Unfortunately, the Ball Bearing Division is operating at capacity and will need to reduce production of
another existing product, the "T" bearing, by 1,000 units per month to provide the 600 "S" bearings
needed each month by the Electric Division. The "T" bearing currently sells for $50 per unit. Variable
costs incurred to produce the "T" bearing are $30 per unit; variable costs to produce the new "S"
bearing would be $60 per unit.

The Electric Division has found an external supplier that would furnish the needed "S" bearings at
$100 per unit. Assume that both the Electric Division and Ball Bearing Division are independent,
autonomous investment centers.

1. Refer to Ecological Products Co. What is the maximum price per unit that Electric Division would be
willing to pay the Ball Bearing Division for the "S" bearing?

ANS:
Electric Division would be willing to pay no more than $100 per unit, the price offered by the external
supplier.

DIF: Moderate OBJ: 13-5

2. Refer to Ecological Products Co. What is the minimum price that Ball Bearing Division would
consider to produce the "S" bearing?

ANS:
The minimum price that Ball Bearing Division would accept is the one that would leave its profits at
the same level as if it only produced "T" bearings. To produce the "S" bearing, Ball Bearing Division
must give up production and sale of 1,000 "T" bearings. These 1,000 bearings generate $20,000 of
contribution margin: [1,000  ($50 - $30) ]. The sales price would have to be high enough to recoup
both the variable costs of the "S" bearings and the contribution margin that is forfeited on the 1,000
units of "T" bearings: $60 + ($20,000/600) = $93.33

DIF: Moderate OBJ: 13-5

3. Refer to Ecological Products Co. What is the minimum price that Ball Bearing Division would
consider to produce the "S" bearing if the Ball Bearing Division did not need to forfeit any of its
existing sales to produce the "S" bearing?

ANS:
The minimum price would be $60, the incremental costs to produce the "S" bearing.

DIF: Moderate OBJ: 13-5

4. Refer to Ecological Products Co. What factors besides price would Electric Division want to consider
in deciding where it will purchase the bearing?

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 ANS:
In particular, Electric Division would want to consider the quality of both suppliers. The factors to be
considered would include: ability to meet delivery deadlines, quality of the product produced, ability
to change as environmental conditions change, willingness to work on future cost reductions/quality
improvements, business reputation, stability of the labor force, and possibility of future price increases.

DIF: Moderate OBJ: 13-5S

Sulphur Steel Corporation

The Wire Products Division of Sulphur Steel Corporation produces "bales" of steel wire that are used
in various commercial applications. The bales sell for an average of $20 each and The Wire Products
Division has the capacity to produce 10,000 bales per month. The Consumer Products Division of
Sulphur Steel Corporation uses approximately 2,000 bales of steel wire each month in its production of
various appliances. The operating information for the Wire Products Division at its present level of
operations (8,000 bales per month) follows:

Sales (all external) $160,000

Variable costs per bale:
Production $5
Selling 2
G&A 3
Fixed costs per bale (based on a 10,000 unit capacity):
Production $2
Selling 3
G&A 4

The Consumer Products Division currently pays $15 per bale for wire obtained from its external
supplier.

5. Refer to Sulphur Steel Corporation. If 2,000 bales are transferred in one month to the Consumer
Products Division at $10 per bale, what would be the profit/loss of the Wire Products Division?

ANS:
The $10 per unit would equal the Division's variable costs ($5 + 2 + 3 = $10), so the contribution
margin per unit is zero. Thus, only the 8,000 units of external sales would generate a contribution
margin of $80,000 (8,000  $10) to cover fixed costs of $90,000 (10,000  $9). So the Division would
show a $10,000 loss.

DIF: Moderate OBJ: 13-5

6. Refer to Sulphur Steel Corporation. For the Wire Products Division to operate at break-even level,
what would it need to charge for the production and transfer of 2,000 bales to the Consumer Products
Division? Assume all variable costs indicated will be incurred by the Wire Products Division.

ANS:
Total fixed costs to Wire are:
Production $2  10,000 = $20,000
Selling $3  10,000 = 30,000
G&A $4  10,000 = 40,000
Total $90,000

Less: Contrib.Margin on Regular Business

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 [$20 - (5 + 2 + 3)]  8,000 (80,000)
Unrecovered Fixed Costs $10,000

which must be covered by CM of inside sales =

Trans.Price  Vol. = SP - [(5 + 2 + 3)  2,000]
SP = $15

DIF: Moderate OBJ: 13-5

7. Refer to Sulphur Steel Corporation. If Wire Products Division transferred 2,000 wire bales to the
Consumer Products Division at 200 percent of full absorption cost, what would be the transfer price?

ANS:

Full absorption cost: Variable Production Cost = $ 5

Fixed Production Cost = 2
Total full absorption cost $ 7
Doubled x 2
Transfer price $14

DIF: Moderate OBJ: 13-5

8. Refer to Sulphur Steel Corporation. If the Consumer Products Division agrees to pay the Wire
Products Division $16 for 2,000 bales this month, what would be Consumer's change in total profits?

ANS:

Proposed transfer price per unit $16

Consumer's current market purchase price per unit 15
Increase in cost per unit of wire to Consumer's $ 1
Times units purchased x 2,000
Decrease in profit due to increased costs $2,000

DIF: Moderate OBJ: 13-5

9. Refer to Sulphur Steel Corporation. Assuming, for this question only, that the Wire Products Division
would not incur any variable G&A costs on internal sales, what is the minimum price that it would
consider accepting for sales of bales to the Consumer Products Division?

ANS:
Wire Division must cover its out of pocket costs or the relevant variable costs; the fixed costs are
irrelevant since they will be incurred regardless of this extra inside business. Thus, the total cost to be
covered is $7 (production, $5; selling, $2).

DIF: Moderate OBJ: 13-5

Floor Products Corporation

The Carpet Division of Floor Products Corporation manufactures a single grade of residential grade
carpeting. The division has the capacity to produce 500,000 square yards of carpet each year. Its
current costs and revenues are shown here:

Sales (400,000 square yards) $2,000,000

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 Variable costs per square yard:
Production $2.00
SG&A 1.00
Fixed costs per square yard (based on 500,000 yard capacity)
Production $0.50
SG&A 1.00

The Housing Division currently purchases 40,000 yards of carpeting (of the grade produced by the
Carpet Division) each year at a cost of $6.50 per square yard from an outside vendor.

10. Refer to Floor Products Corporation. If the autonomous Housing and Carpet Divisions enter
negotiations on the internal transfer of 40,000 square yards of carpeting, what is the maximum price
that will be considered?

ANS:
The maximum price or ceiling is the current purchase price of the buying division or $6.50 per yard.

DIF: Moderate OBJ: 13-5

11. Refer to Floor Products Corporation. If the autonomous Housing and Carpet Divisions enter
negotiations on the internal transfer of 40,000 square yards of carpeting, what is the Carpet Division's
minimum price?

ANS:
The minimum price acceptable to Carpet is its incremental cost of $3 ($2 + $1) per square yard.

DIF: Moderate OBJ: 13-5

12. Refer to Floor Products Corporation. If the Housing and Carpet Divisions agree on the internal transfer
of 40,000 square yards of carpet at a price of $4.50 per square yard, how will the profits of the
Housing Division be affected?

ANS:

Current external purchase price $6.50

Proposed transfer price 4.50
Reduction in purchase price per yard $2.00
Times yards acquired x 40,000
Increase in profits $80,000

DIF: Moderate OBJ: 13-5

13. Refer to Floor Products Corporation. If the Housing and Carpet Divisions agree on the internal transfer
of 40,000 square yards of carpet at a price of $4.00 per square yard, how will overall corporate profits
be affected?

ANS:

Current outside purchase price per square yard $6.50

Carpet's variable cost per square yard 3.00
Savings per square yard to Housing Division
& corporate $3.50
Times number square yards bought x 40,000

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 Savings to corporate and increase in profits $140,000

DIF: Moderate OBJ: 13-5

14. Refer to Floor Products Corporation. Assume, for this question only, that the Carpet Division is
producing and selling 500,000 square yards of carpet to external buyers at a price of $5 per square
yard. What would be the effect on overall corporate profits if Carpet Division reduces external sales of
carpet by 40,000 square yards and transfers the 40,000 square yards of carpet to the Housing Division?

ANS:
Since Carpet is operating at full capacity, it would lose the contribution margin on the 40,000 square
yards. However, the Housing Division would not have to buy externally. Thus,

Lost CM ($2  40,000 yd) = $(80,000)

Gained CM ($3.50  40,000 yd) = 140,000
Net increase in corporate profits $ 60,000

DIF: Moderate OBJ: 13-5

Kingwood Corporation

Kingwood Corporation is comprised of two divisions: X and Y. X currently produces and sells a gear
assembly used by the automotive industry in electric window assemblies. X is currently selling all of
the units it can produce (25,000 per year) to external customers for $25 per unit. At this level of
activity, X's per unit costs are:

Variable:
Production $7
SG&A 2
Fixed:
Production 6
SG&A 5

Y Division wants to purchase 5,000 gear assemblies per year from X Division. Y Division currently
purchases these units from an outside vendor at $22 each.

15. Refer to Kingwood Corporation. What is the minimum price per unit that X Division could accept
from Y Division for 5,000 units of the gear assembly and be no worse off than currently?

ANS:
X Division is operating and selling outside at full capacity so minimum price is equal to the variable
cost to make and sell plus the lost contribution margin from outside sales:

VC: Production $7
SGA 2 $ 9
Contribution margin 16
Selling price $25

DIF: Moderate OBJ: 13-5

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 16. Refer to Kingwood Corporation. What will be the effect on overall corporate profits if the two
divisions agree to an internal transfer of 5,000 units?

ANS:
Corporate profits will decrease by forcing the transfer.

CM per units earned by X is from external sales $25 - [$7 + $2] $16
Times units to be sold x 5,000
Decrease in CM to X and XY Corp. $80,000
Net savings to buy internally
rather than externally [$22 - $9] $13
Times units to be purchased x 5,000
Savings by buying internally $ 65,000
Net effect on XY Corp. profits $(15,000)

DIF: Moderate OBJ: 13-5

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