Problem: Meredith Motor Works has just acquired a new Battery Division. The Battery Division produces a standard 12volt battery that it sells to retail outlets at a competitive price of $20. The retail outlets purchase about 600,000 batteries a year. Since the Battery Division has a capacity of 1,000,000 batteries a year, top management is thinking that it might be wise for the company's Automotive Division to start purchasing batteries from the newly acquired Battery Division.
The Automotive Division now purchases 300,000 batteries a year from an outside supplier, at a price of $18 per battery. The discount from the competitive $20 price is a result of the large quantity purchased.
The Battery Division's cost per battery is shown below:
| Direct materials |
8 |
| Direct labor |
4 |
| Variable overhead |
2 |
| Fixed overhead |
2 |
| Total cost |
16 |
*Based on 1,000,000 batteries.
Both divisions are to be treated as investment centers, and their performance is to be evaluated by the ROI formula.
Required:
Q1. What transfer price would you recommend and why?
Q2. What transfer price would you recommend if the Battery Division is now selling 1,000,000 batteries a year to retail outlets?
Q3. Refer to (1). Top Management has decided the transfers between the two divisions should be at $19. Compute the effect of the transfer on the net income for the Battery Division, Automotive Division, and the total company.