A company makes remotely controllable model car. The company has two compartment

Question

A company makes remotely controllable model car. The company has two compartment, C1 and C2. Division C1 makes car model kit. Compartment C2 assembles and configures model car. A new car model has been developed of which the company will sell for $175 each. Compartment C2 of the company has planned to produce 1,000 units of fully assembled model car using its idle capacity. The compartment can either purchase the model kit from Compartment C1 or purchase it from an outside supplier for $140. The company has a policy that internal transfers are priced at their fully allocated costs.

Assume that the variable cost and allocated fixed cost for each car model kit at Compartment C1 are $80 and $30, respectively.

Also assume that the assembling and administrative variable costs for each model car at Compartment C2 are $55 and $15, respectively.

(1) Assume that Compartment C1 has idle capacity of producing the 1,000 sets of car model kit for Compartment C2. Should the Compartment C2 purchase the car model kit from Compartment C1? Would the company as a whole benefit if Compartment C2 decides to purchase from Compartment C1?

(2) Assume that Compartment C1 doesn’t have any idle capacity and the required car model kit can be sold to outside customers for $125. Would the company as a whole benefit if the Compartment C2 purchases the model kit from Compartment C1?

(3) Assume that the allocated fixed cost for each model car at Compartment C2 is $40. The 1,000 model cars are produced using the model kit from Compartment C1 for the company’s EU sales compartment, which sells the model car for $240 each. Suppose the EU and US governments allow either the variable or fully allocated cost to be used as a transfer price. The US income tax is 35%, the EU income tax is 60%, and the import duty to EU is 15%. Which price should the company use to minimize the total of income taxes and import duties? Compute the saving from your choice of transfer price versus the other.

(4) If EU has passed a new law decreasing the income tax rate to 50% and increasing the import duty to 20%, what would be the choice of transfer price in (3)?

Explanation / Answer

C1 C2 Variable cost 80 allocated fixed cost 30 Total cost 110 Total purchase price 140 1) As the compartment C1 has idle capacity , the compartment C2 should purchase the car model kit from compartment C1 as the transfer price of Compartment C1 is lower than the purchase price from outside vendor The company as a whole will benefit if the transfer is done from the two departments because the idle capacity of compartment will get utilised and the overall cost of the department will reduce 2) Variable cost 80 allocated fixed cost 30 oppurtunity cost ( 125-110) 15 Total cost 125 Total purchse price 140 Yes the company as a whole would benefit if the compartment C2 purchases the kit from compartment C1 because the input cost of compartment C2 is still lower than the outside cost and the company as awhole will make higher profit by selling the final product (175 -125) rather than compartment C1 making a profit of 15 ( 125-110) by selling to outside customers

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