Assume the Following Facts Regarding a Product That Division P

question 107

Essay

Assume the following facts regarding a product that Division P can sell internally (to Division B) or externally on the open market. Incremental (i.e., out-of-pocket) cost to Division P for each unit produced = $12. External purchase price, to be paid by Division B = $13.50. Total units needed (annually) by Division B = 1,000.
Required:
1. Assume that there are no alternative uses for Division P's facilities. Determine whether the company as a whole will benefit if Division B purchases the product externally. At what amount should the transfer price be set such that each divisional manager, acting in the best interest of his or her own division, take actions that are in the best interest of the company as a whole?
2. Assume that Division P's facilities would not otherwise be idle if it didn't produce the product for Division B. By not producing the product for Division B, the freed-up facilities would be used to generate a net cash benefit of $1,800. Should Division B purchase from suppliers? (Show calculations.)
3. Assume that for the foreseeable future there are no alternative uses for Division P's facilities, and that the outside supplier's cost to Division B drops by $2. Under this circumstance, should Division B purchase externally? At what amount should the transfer price be set such that each divisional manager, acting in the best interest of his or her division, would take actions that are in the best interest of the company as a whole?

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Definitions:

Correlation Coefficient

A numerical measure of the strength and direction of a linear relationship between two variables.

Linear Relationship

A direct correlation between two variables that can be represented with a straight line in a graph.

Coefficient Of Determination

A statistical measure represented by R² that assesses the proportion of variance in the dependent variable predictable from the independent variables.

Correlation Coefficient

A numerical indicator that determines the magnitude of the correlation between the relative fluctuations of two variables.