Assignment Detail

Assignment ID: FG133141736

Question – The transfer price of the wind turbine generator – The manufacturing divisions of Sirocco Inc. operate as separate profit centers. Each divisional manager has been delegated full authority on all decisions involving the sale of that division’s output both to outsiders and to other divisions of Sirocco. Each divisional manager is evaluated on the basis of the division’s return on investment. NT1 division is responsible for manufacturing the wind turbine generator and recently acquired a larger factory to increase its production capacity. As a result, the divisional manager, Mr. Emad, has increased the selling price of the generator component to cover for his division’s incremental capacity costs. ST1 division has in the past always purchased 100 units of the generator component from division NT1. However, when the manager of ST1, Mr. Yasir, was informed that division NT1 is increasing the generator’s selling price from $400 to $450, he decided to approach Mr. Emad to see if a more favorable lower transfer price could be arranged for the intermediate product. Mr. Yasir suggested a transfer of 100 generators at $410 per unit to Mr. Emad. Mr. Emad, however, refused to lower the price of the generator as he is worried that his division might not be able to earn an adequate return on its investment unless it raises its price. Consequently, Mr. Yasir decided to purchase the generator component from external suppliers as it only costs $420. In response to this, Mr. Emad appealed to Mr. Mehdi, the president of the company, for support in the dispute with Mr. Yasir. As a result, Mr. Mehdi collected the following information regarding the unit cost of making the generator component by NT1 division and its production capacity:

Direct Materials $ 135

Direct Labor $ 80

Variable Manufacturing Overhead $ 50

Fixed Manufacturing Overhead $ 45

Production Capacity 200 units

Accordingly, Mr. Mehdi requested, Mr. Ahmed, the newly hired financial controller, to determine the optimal transfer price and assess whether Sirocco, the company, as a whole will be at a disadvantage if Mr. Yasir, manager of ST1 division, purchases the generator component from external suppliers for $420 per unit.

Required – Assuming you are Mr. Ahmed:

1. Suppose that Division NT1 is producing at capacity and can sell the entire production output to outside customers, should Mr. Emad accept Mr. Yasir’s request for a lower transfer price? Explain.

2. Suppose that Division NT1 is currently selling 50% of its production output to outside customers, what should the minimum and maximum transfer prices for the generator component be set at? Should Mr. Emad consider Mr. Yasir’s suggested transfer price?

3. Suppose that there are no alternative uses for internal facilities of division NT1. Determine whether Sirocco as a whole will be at a disadvantage if Mr. Yasir purchases the generator component from external suppliers for $420 per unit. Show your calculations.

4. Suppose that the internal facilities of division NT1 would not otherwise be idle. By not producing the 100 units for division ST1, division NT1’s equipment and other facilities would be used for other production operations that would result in annual cash-operating savings of $18,500. Should Mr. Yasir purchase from external suppliers? Show your calculations.