Phoenix Inc., a cellular communication company, has multiple business units, organized as divisions. Each division’s management is compensated based on the division’s operating income. Division A currently purchases cellular equipment from outside markets and uses it to produce communication systems. Division B produces similar cellular equipment that it sells to outside customers—but not to division A at this time. Division A’s manager approaches division B’s manager with a proposal to buy the equipment from division B. If it produces the cellular equipment that division A desires, division B will incur variable manufacturing costs of $60 per unit.
Relevant Information about Division B
Sells 77,500 units of equipment to outside customers at $130 per unit
Operating capacity is currently 80%; the division can operate at 100%
Variable manufacturing costs are $70 per unit
Variable marketing costs are $8 per unit
Fixed manufacturing costs are $800,000
Income per Unit for Division A (assuming parts purchased externally, not internally from division B)
Sales revenue = $320 Manufacturing costs: Cellular equipment = 80 Other materials = 10 Fixed costs = 40 Total manufacturing costs = 130 Gross margin = 190 Marketing costs: Variable = 35 Fixed = 15 Total marketing costs = 50 Operating income per unit = $140 Required:
1. Division A wants to buy 36,000 units from division B at $75 per unit. Determine the contribution margin for each type sale by division B. Should division B accept or reject the proposal? How would your answer differ if (a) division A requires all 36,000 units in the order to be shipped by the same supplier and what would be the net operating loss or gain to division B and the firm as a whole, or (b) division A would accept partial shipment from division B and what would be the benefit from this alternative to division B?
2. What is the range of transfer prices over which the divisional managers might negotiate a final transfer price?