Tanker Ltd has two divisions, Division A and B, which are profit centres. During

Question

Tanker Ltd has two divisions, Division A and B, which are profit centres. During 2003, Division A purchased a product called leggos from Division B at a cost of $75 per unit. Division A processes leggos into a final product, which is sold to outside customers.

In 2003, Division B plans to raise the transfer price of leggos to $90 per unit. Angered by this move, Division A has sought alternative suppliers for the product. The best quote came from the XYZ Company who agreed to supply leggos at $80 per unit for 2004. It is estimated that Division A will require 8 000 units during 2004, which will be processed at a cost of $15 per unit. Division A plans to sell the final product for $135 in 2004.

Data for Division B for the 2004 production of leggos are as follows:

Variable costs per unit $70

Fixed costs for 2004 $15 000

Production capacity 10 000 units

Selling price to outside customers $100 per unit

Division B estimates that in 2004, if it transfers leggos to Division A then it would supply 2 000 units to outside customers. However, if it did not supply Division A with leggos, the maximum demand from outside customers would be no greater than 4 000 units.

The manager of Division B has refused to supply leggos to Division A at a transfer price lower than $90 per unit, as this would lower the overall profits of his division.

Required:

(a) Calculate the contribution margins of each Division, and of Tanker Ltd, resulting from the following scenarios:

(i) The internal transfer takes place at $90 per unit

(ii) Division A decides to purchase leggos from the outside supplier

(b) Should Division A purchase leggos from the outside supplier, or from Division B? Provide financial and qualitative reasons to support your argument.

Explanation / Answer

a) i) Internal transfer takes place at $ 90             Division A purchased from outside Division B Quantity reqired 8000 8000 Selling price 135 135 Purchase cost 80 90 processing cost 15 15 Total variable cost 95 105 Contribtion per leggo 40 30 Total contribution 240000             Division B sold to outside Division A Total Quantity reqired 2000 8000 Selling price 100 90 Variable cost 70 70 Contribtion per leggo 30 20 Total contribution 60000 160000 220000 Total contribtion of Tanker Ltd Total contribtion of Division A 240000 Total contribtion of Division B 220000 Total contribtion of Tanker Ltd 460000 ii) Division A purchases from outside Division A Quantity reqired 8000 Selling price 135 Purchase cost 80 processing cost 15 Total variable cost 95 Contribtion per leggo 40 Total contribution 320000 Division B sold to outside Quantity reqired 4000 Selling price 100 Variable cost 70 Contribtion per leggo 30 Total contribution 120000 Total contribtion of Tanker Ltd Total contribtion of Division A 320000 Total contribtion of Division B 120000 Total contribtion of Tanker Ltd 440000 b) Division A should purchase the leggo from Division B because the total contribution of Tanker Ltd is higher if Division A purchases from Division B rather than from outside, even though individually Division A contribution is higher when it purchases from outside, but in the overall interest of the company as a whole Division A should purchase from Division B

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