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Sir, This is the question from the kaplan kit Q70 on page 65.
C is asking for the quotation from A.
A Has budgeted information as follows:
Maximum capacity 150000
External sales 110000
SP 35
VC 22
FC 1080000
Capital employed 3200000
Target residual imcome 180000
They uses RI as divisional performance ( cost of capital 12% )Further notes for C:
X could supply for 28 but with annual order of 50000bits
Z could supply 33 per bit with any quantity order.Now the Question is C has Ask the Divition A for the 60000 quotes. What would be the TP to meet its residual imcome target. Or could you please give me some Detail regarding this. Thank you
A wants to meet its target RI of 180,000.
RI is profit less (12% x capital employed).
12% x capital employed = 12% x 3200000 = 384,000.So they need to achieve a profit of 180,000 + 384,000 = 564,000.
Their fixed costs (be definition) will remain unchanged at 1,080,000, and so they need a contribution (profit before fixed costs) of 564,000 + 1,080,000 = 1,644,000.
Because they can only produce 150,000 units, if they supply 60,000 to C, then they can only sell 90,000 externally.
These 90,000 will earn them a contribution of 90,000 x $13 (35-22) = 1,170,000.So the extra contribution that they need from A is 1,644,000 – 1,170,000 = 474,000.
They need to get this from the 60,000 units sold to A, so they need to earn a contribution per unit of 474,000/60,000 = $7.90.Since the variable cost per unit is $22, to generate a contribution of $7.90 per unit, they will need to charge A with 7.90 + 22 = $29.90 per unit.
hello Sir,
I want to ask regarding part b of this question I am confused if what is the current policy
i am ok with the propsed policy based on opportunity cost but still the impact of current policy on the group and the impact of new policy on division A is unclear to me I mean how they have reached to net losses in both cases please explain them in easy way bcz the method in the solution is really confusing me
. thankyouIf they were not divisionalised (and therefore transfer prices were irrelevant), then the variable cost to the whole company of making Bits would be $22 and it would be silly of the company to buy them from outside at a higher price.
As it is, because of the transfer price being $29.50, Division C prefers to buy them from X because they are only charging $28.00.
So…..as far as they whole company is concerned, they are paying an extra $6 (28 – 22) more than they need to for each unit – it is costing them a total of 60,000 x $6 = 360,000 p.a..
However the fact that C is buying externally does mean that A can sell a few more outside. (Their maximum capacity is 150,000 and if they were supplying C with 60,000 then they could only sell 90,000 externally. Because C is buying externally, it means that A can sell the full 110,000 outside – an extra 20,000.)
Selling more externally does benefit the company overall – it will gain them extra contribution of 20,000 x (35 – 22) = 260,000.So the net impact of the current policy is that the company is spending 360,000 more than they need to, but earning 260,000 more than they otherwise would – so it is costing them a net 100,000.
(It does not mean that the company is making an overall net loss for the year of 100,000 – we cannot calculate what the overall profit or loss if for the company because we do not know what C is doing with the Bits! (Presumably they are using them somewhere and then selling something. What the 100,000 means is that the company will be making 100,000 less profit than they could have made, simply because of the current transfer price policy.)
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