Question - Boots Company has two divisions. Land Division, which has operating assets of $80,000,000 produces and sells 900,000 units of a product at a market price of $140 per unit. Variable costs total $40 per unit. The division also assigns $70 of fixed costs to each unit based on total capacity of 1,000,000 units.
Sea Division wants to purchase 200,000 units from Land. However, it is only willing to pay $80 per unit because it has an opportunity to accept a special order at a reduced price. The order is economically justifiable only if Sea Division can acquire Land Division's output at a reduced price.
Boots Company's cost of capital is 15%.
Required:
What is the sales revenue at this transfer price?
What is the residual income for Land Division without the transfer to Sea Division?
What is Land Division's residual income if it transfers 200,000 units to Sea Division at $80 each?
What is the minimum transfer price for the 200,000-unit order that Land would accept if it were willing to maintain the same residual income with the transfer as it would accept by selling its 900,000 units to the outside market?
If Land Division had no capacity constraints, what is the minimum transfer price it could accept on the order from Sea Division? Explain your answer.
If Land Division could sell all units produced to the outside market, what transfer price would you recommend? Why?