The Allison-Chambers Corporation, manufacturer of tractors and other heavy farm equipment, is organized along decentralized product lines, with each manufacturing division operating as a separate profit centre. Each division manager has been delegated full authority on all decisions involvingthe sale of that division’s output both to out siders and to other divisions of Allison-Chambers. Division C has in the past always purchased its requirement of a particular tractor-engine component from Division A. However, when informed that Division A is increasing its selling price to $150, Division C’s manager decides to purchase the engine component from external suppliers.
Division C can purchase the component for $135 per unit in the open market. Division A insists that, because of the recent installation of some highly specialized equipment and the resulting high depreciation charges, it will not be able to earn an adequate return on its investment unless it raises its price. Division A’s manager appeals to top management of Allison-Chambers for support in the dispute with Division C and supplies the following operating data:
C’s annual purchases of the tractor-engine component…….1,000 units
A’s variable cost per unit of the tractor-engine component…. $120
A’s fixed cost per unit of the tractor-engine component…… $ 20
1. Assume that there are no alternative uses for internal facilities of Division A. Determine whether the company as a whole will benefit if Division C purchases the component from external suppliers for $135 per unit. What should the transfer price for the component be set at so that division managers acting in their own divisions’ best interests take actions that are in the best interest of the company as a whole?
2. Assume that internal facilities of Division A would not otherwise be idle. By not producing the 1,000 units for Division C, Division A’s equipment and other facilities would be used for other production operations that would result in annual cash-operating savings of $18,000. Should Division C purchase from external suppliers? Show your computations.
3. Assume that there are no alternative uses for Division A’s internal facilities and that the price from outsiders drops $20. Should Division C purchase from external suppliers? What should the transfer price for the component be set at so that division managers acting in their own divisions’ best interests take actions that are in the best interest of the company as a whole?