The president of Charlottetown Inc. has given the managers of the company's three decentralized divisions (O'Leary, Alberton, and Summerside) the authority to decide whether to sell externally or internally at a transfer price the division managers determine. Market conditions are such that internal or external sales will not affect market or transfer prices. Intermediate markets will always be available for the divisions to purchase their manufacturing needs or sell their product.
Division managers attempt to maximize their contribution margin at the current level of operating assets for their divisions.
The Alberton Division manager is considering the following two alternative orders:
Summerside Division needs 1,500 units of a motor that Alberton Division can supply. To manufacture these motors, Alberton would purchase components from O'Leary Division at a transfer price of $600 per unit; O'Leary's variable cost for these components is $300 per unit. Alberton Division would further process these components at a variable cost of $500 per unit.
If Summerside cannot obtain the motors from Alberton, it will purchase the motors from Montague Company for $1,500 per unit. Montague Company would also purchase 1,500 components from O'Leary at a price of $400 for each motor; O'Leary's variable cost for these components is $200 per unit.
New London Company wants to buy 1,750 similar motors from the Alberton Division for $1,250 per unit. Alberton would again purchase components from O'Leary Division, in this case at a transfer price of $500 per unit; O'Leary's variable cost for these components is $250 per unit. Alberton Division would further process these components at a variable cost of $400 per unit.
Alberton Division's plant capacity is limited, and therefore the company can accept either the New London contract or the Summerside order but not both. The president of Charlottetown Inc. and the manager of Alberton Division agree that it would not be beneficial in the short or long run to increase capacity.
a. If the Alberton Division manager wants to maximize the short-run contribution margin, determine whether Alberton Division should (1) sell motors to Summerside Division at the prevailing market price or (2) accept New London Company's contract.
Support your answer with appropriate calculations.
b. Without prejudice to your answer to (a), assume that Alberton Division decides to accept the New London contract. Determine whether this decision is in the best interest of Charlottetown Inc. Support your answer with appropriate calculations.
This question was answered on: Jul 11, 2017
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