Tanker Ltd has two divisions, Division A and B, which are profit centres. During 2003, Division A purchased a product called leggos from Division B at a cost of $75 per unit. Division A processes leggos into a final product, which is sold to outside customers.
In 2003, Division B plans to raise the transfer price of leggos to $90 per unit. Angered by this move, Division A has sought alternative suppliers for the product. The best quote came from the XYZ Company who agreed to supply leggos at $80 per unit for 2004. It is estimated that Division A will require 8 000 units during 2004, which will be processed at a cost of $15 per unit. Division A plans to sell the final product for $135 in 2004.
Data for Division B for the 2004 production of leggos are as follows:
Variable costs per unit $70
Fixed costs for 2004 $15 000
Production capacity 10 000 units
Selling price to outside customers $100 per unit
Division B estimates that in 2004, if it transfers leggos to Division A then it would supply 2 000 units to outside customers. However, if it did not supply Division A with leggos, the maximum demand from outside customers would be no greater than 4 000 units.
The manager of Division B has refused to supply leggos to Division A at a transfer price lower than $90 per unit, as this would lower the overall profits of his division.
Required:
(a) Calculate the contribution margins of each Division, and of Tanker Ltd, resulting from the following scenarios:
(i) The internal transfer takes place at $90 per unit
(ii) Division A decides to purchase leggos from the outside supplier
(b) Should Division A purchase leggos from the outside supplier, or from Division B? Provide financial and qualitative reasons to support your argument.