West Industries is a highly decentralized corporation with independent operating divisions.
Each division is evaluated and rewarded based on its total net income. One of the divisions, Visic, manufactures and sells air conditioners. Visic is projecting sales of 17,400 for next year.
Another division, Weber, makes and sells compressors. Its projected income statement for next year follows:
Weber Division
Pro forma income statement
For next year
Per unit Total
Sales revenues $100 $ 6,400,000
Less cost of goods sold:
Direct materials 12 768,000
Direct labour 8 512,000
Variable overhead 10 640,000
Fixed overhead 11 704,000
41 2,624,000
Gross profit 59 3,776,000
Operating expenses:
Variable selling expenses 6 384,000
Fixed selling expenses 4 256,000
Fixed administrative expenses 7 448,000
17 1,088,000
Pre-tax net income $ 42 $ 2,688,000
Weber has the capacity to produce 75,000 compressors annually. Visic currently purchases compressors from an outside source at $70, and proposes that Weber transfer compressors to it at a transfer price of $50. The Visic manager justified the low bid based on some cost savings that should be realized if compressors are transferred. Because specifications for this compressor are slightly different from Weber's standard model, $1.50 of direct materials cost per compressor can be saved and no variable selling expenses will be incurred on compressors transferred.
Required:
a) Compute the minimum transfer price Weber should accept.
b) Compute the estimated effect on Weber's net income if the 17,400 compressors are transferred at $50 each.
c) Determine whether it would be in West Industries' best interest for Weber to transfer compressors at $50 each.