“I know headquarters wants us to add that new product line,” said Fred Halloway, manager of Kirsi Products’ East Division. “But I want to see the numbers before I make a move. Our division’s return on investment (ROI) has led the company for three years, and I don’t want any letdown.”
Kirsi Products is a decentralized wholesaler with four autonomous divisions. The divisions are evaluated on the basis of ROI, with year-end bonuses given to divisional managers who have the highest ROI. Operating results for the company’s East Division for last year are given below:
Sales / $ / 26,000,000
Variable expenses / 13,000,000
Contribution margin / 13,000,000
Fixed expenses / 10,920,000
Net operating income / $ / 2,080,000
Divisional operating assets / $ / 5,200,000
The company had an overall ROI of 18% last year (considering all divisions). The company’s East Division has an opportunity to add a new product line that would require an investment of $3,240,000. The cost and revenue characteristics of the new product line per year would be as follows:
Sales / $ 10,044,000
Variable expenses / 65% of sales
Fixed expenses / $ 2,802,276
Required:
1. / Compute the East Division’s ROI for last year; also compute the ROI as it would appear if the new product line is added. (Round your intermediate calculations and final answers to 2 decimal places. Omit the "%" sign in your response.)
ROI
Present / %
New product line alone / %
Total / %
4. / Suppose that the company’s minimum required rate of return on operating assets is 15% and that performance is evaluated using residual income.
a. / Compute the East Division’s residual income for last year; also compute the residual income as it would appear if the new product line is added. (Omit the "$" sign in your response.)
Residual income
Present / $
New product line alone / $
Total / $

2.

Problem 11A-5 Basic Transfer Pricing [LO5]

In cases 1-3 below, assume that Division A has a product that can be sold either to Division B of the same company or to outside customers. The managers of both divisions are evaluated based on their own division’s return on investment (ROI). The managers are free to decide if they will participate in any internal transfers. All transfer prices are negotiated. Treat each case independently.
Case
1 / 2 / 3 / 4
Division A:
Capacity in units / 51,000 / 298,000 / 101,000 / 202,000
Number of units now being sold to outside
customers / 51,000 / 298,000 / 74,000 / 202,000
Selling price per unit to outside customers / $101 / $40 / $69 / $45
Variable costs per unit / $65 / $19 / $42 / $30
Fixed costs per unit (based on capacity) / $24 / $8 / $27 / $5
Division B:
Number of units needed annually / 9,500 / 66,000 / 22,000 / 64,000
Purchase price now being paid to an outside
supplier* / $92 / $40 / $69 / —
* Before any purchase discount.
Required:
1. / Refer to case 1. A study has indicated that Division A can avoid $6 per unit in variable costs on any sales to Division B.
a. / What is the minimum transfer price for Division A? (Omit the "$" sign in your response.)
Minimum transfer price / $
b. / What is the maximum transfer price for Division B? (Omit the "$" sign in your response.)
Maximum transfer price / $
c. / Will the managers agree to a transfer?
/ Yes
/ No
2. / Refer to case 2. Assume that Division A can avoid $3 per unit in variable costs on any sales to Division B.
a-1. / What is the minimum transfer price for Division A? (Omit the "$" sign in your response.)
Minimum transfer price / $
a-2. / What is the maximum transfer price for Division B? (Omit the "$" sign in your response.)
Maximum transfer price / $
a-3. / Would you expect any disagreement between the two divisional managers over what the transfer price should be?
/ Yes
b. / Assume that Division A offers to sell 66,000 units to Division B for $39 per unit and that Division B refuses this price. What will be the loss in potential profits for the company as a whole? (Input the amount as a positive value. Omit the "$" sign in your response.)
Loss in potential profits for the company / $ 198000
3. / Refer to case 3. Assume that Division B is now receiving a 6% price discount from the outside supplier.
a-1. / What is the minimum transfer price for Division A? (Omit the "$" sign in your response.)
Minimum transfer price / $ 42
a-2. / What is the range of transfer price the manager's of both divisions should agree? (Round your answers to 2 decimal places. Omit the "$" sign in your response.)
The transfer price can be a lowest of $ 42and a highest of $ 64.86.
a-3. / Will the managers agree to a transfer?
/ Yes
b. / Assume that Division B offers to purchase 22,000 units from Division A at $59.86 per unit. If Division A accepts this price, would you expect its ROI to increase, decrease, or remain unchanged?
Division A's ROI should / increase
4. / Refer to case 4. Assume that Division B wants Division A to provide it with 64,000 units of a different product from the one that Division A is now producing. The new product would require $25 per unit in variable costs and would require that Division A cut back production of its present product by 32,000 units annually. What is the lowest acceptable transfer price from Division A's perspective? (Round your intermediate and final answers to 2 decimal places. Omit the "$" sign in your response.)
Transfer price / $ 32.50

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Worksheet / Difficulty: Medium
Problem 11A-5 Basic Transfer Pricing [LO5] / Learning Objective: 11A-05 (Appendix 11A) Determine the range, if any, within which a negotiated transfer price should fall.