The Scissor Brothers Corp. produces and sells scissors (of course). Scissors Bro

Question

The Scissor Brothers Corp. produces and sells scissors (of course). Scissors Bros. is organized into two divisions, the UP division and the DOWN division. The UP division manufactures 30,000 pairs of scissors per year, selling 10,000 units externally at a price of $8 each and transferring the remaining 20,000 units internally to the DOWN division. The DOWN division modifies these 20,000 units and sells them to external clients. The UP division incurs variable manufacturing costs of $4.50 for each of its 30,000 output units and total annual fixed manufacturing cost of $60,000. You can ignore SG&A costs for this exercise.
Scissor Brothers have adopted a market-based transfer pricing policy. For each pair of scissors it receives from the UP division, the DOWN division pays the weighted average external price the UP division charges its customers outside Scissor Brothers. The current transfer price thus equals $8.
Ana Patronic, the manager of the UP division receives an offer from Jean-Georges, an international hair salon supplier. Jean-Georges offers to buy 4,000 pairs of scissors at a price of $6.30 each, knowing that the entire scissors industry (including Scissor Brothers) has excess capacity at this time. There are no additional fixed manufacturing, SG&A, or transportation costs associated with this offer. UP’s variable manufacturing costs are $4.50 also for each of the units Jean-Georges is requesting. Accepting Jean-Georges’ offer would not affect the current price of $8 charged to existing external customers.
Question 1:
a. What is the “contribution margin” associated with this special order from Jean-George. What is the appropriate interpretation of this number? (Note: Recall from your Cost Accounting Class that contribution margin is the revenue you generate minus all variable costs.

b. Compute the resulting change in the UP division’s profit if they accept Jean-Georges’ offer. Will Ana Patronic accept this offer if she aims to maximize the UP division’s profit?
c. Would the top management of Scissor Brothers Corp. want the UP division to accept the offer? Compute the change in firm-wide profit associated with Jean-Georges’ offer.

Explanation / Answer

Requirement a Contribution margin associated with this special order fromJean-George Units   = 4000 Total Amount Per unit Sales Revenue 25200 6.3 Variable costs 18000 4.5 Contribution margin 7200 Interpretation implies that any revenue received above the variable costs is a pure operating profit given that fixed expenses are constant and business is already doing profit. Requirement b Existing profit made by UP Division Units   = 30000 Total Amount Per unit Sales Revenue 240000 8 Variable costs 135000 4.5 Contribution margin A 105000 Revised profit made by UP division Units   = 34000 Total Amount Per unit Transfer to Down division 20000 150286 7.514 Sales Revenue to external customers 10000 80000 8 Sales Revenue for Jean-Geroge 4000 25200 6.3 Total sales 255486 Variable costs 153000 4.5 Contribution margin B 102486 Profit of UP division is decreased by A-B 2514 If Ana Patronic wants to maximize the UP division's profit, she should not accept the offer. Working Note : Weighted average price =(4000*6.3+10000*8)/14000 7.51428571 Requirement c Yes, Top management would definitely want UP division to accept the offer as firm-wide profit will increase by 7200 Since , it will not affect the existing price of scissors to external customers and there is not any change in demand for scissors due to this order, Anything received above the variable cost from new order is incremental revenu(profit) for the firm.

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