Division a Makes a Part That It Sells to Customers

question 58

Multiple Choice

Division A makes a part that it sells to customers outside of the company. Data concerning this part appear below:
$$\begin{array} { l r r } \text { Selling price to outside customers } & \$ 40 \\\text { Variable cost per unit } & \$ 30 \\\text { Total fixed costs } & \$ 10,000 \\\text { Capacity in units } & 20,000\end{array}$$
Division B of the same company would like to use the part manufactured by Division A in one of its products. Division B currently purchases a similar part made by an outside company for $38 per unit and would substitute the part made by Division A. Division B requires 5,000 units of the part each period. Division A has ample capacity to produce the units for Division B without any increase in fixed costs and without impacting sales to outside customers. If Division A sells to Division B, the variable cost per unit would be $1 lower than when selling to outside customers. What should be the lowest acceptable transfer price from the perspective of Division A?

• A) $40.
• B) $38.
• C) $30.
• D) $29.

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Definitions:

Operating Leverage

A measure of how revenue growth translates into growth in operating income, indicating the proportion of fixed versus variable costs a company has.

ROCE

Return on Capital Employed (ROCE) is a financial ratio that measures a company's profitability in terms of the capital it uses.

ROE

Return on Equity; a measure of financial performance calculated by dividing net income by shareholders' equity, indicating how much profit a company generates with the money shareholders have invested.

Debt

Debt represents money borrowed by one party from another, under the condition that it is to be paid back with interest, typically used for business operations or purchases.