General Instrumentation Company manufactures dashboard instruments for heavy construction equipment. The firm is based in Baltimore, but operates several divisions in the United States, Canada, and Europe. The Hudson Bay Division manufactures complex electrical panels that are used in a variety of the firm’s instruments. There are two basic types of panels. The high-density panel (HDP) is capable of many functions and is used iii the most sophisticated instruments, such as tachometers and pressure gauges. The low-density panel (LDP) is much simpler and is used in less-complicated instruments. Although there are minor differences among the different high-density panels, the basic manufacturing process and production costs are the same. The high-density panels require considerably more skilled labor than the low-density panels, but the unskilled labor needs arc about the same. Moreover, the direct materials in the high-density panel run substantially more than the cost of materials in the low-density panels. Production costs are summarized as follows:

The annual fixed overhead in the Hudson Bay Division is $1,000,000. There is a limited supply of skilled labor available in the area, and the division must constrain its production to 40,000 hours of skilled labor each year. This has been a troublesome problem for Jacqueline Ducharme, the division manager. Ducharme has successfully increased demand for the LDP line to the point where it is essentially unlimited. Each LDP sells for $28. Business also has increased in recent years for the HDP, and Ducharme estimates the division could now sell anywhere up to 6,000 units per year at a price of $115.
On the other side of the Atlantic, General Instrumentation operates its Volkmar Tachometer Division in Berlin. A recent acquisition of General Instrumentation, the division was formerly a German company known as Volkmar Construction Instruments. The division’s main product is a sophisticated tachometer used in heavy-duty cranes, bulldozers, and backhoes. The instrument, designated as a TCH—320, has the following production costs.
TCH—320
Unskilled labor (.5 hour @ $9) .......... $ 4.54
Skilled labor (3hours@$17) ............ 51.00
Raw material .................. 11.50
Purchased components ............... 150.00
Variable overhead ................. 11.00
Total variable cost .................$228.00

The cost of purchased components includes a $145 control pack currently imported from Japan Fixed overhead in the Volkmar Tachometer Division runs about $800,000 per year. Both skilled unskilled labors are in abundant supply. The TCH—320 sell for $270.
Bertram Mueller, the division manager of the Volkinar Tachometer Division, recently attended a high-level corporate meeting in Baltimore. In a conversation with Jacqueline Ducharme, it was apparent that Hudson Bay’s high-density panel might be a viable substitute for the control pack currently imported from Japan and used in Volkniar’s TCH—320. Upon returning to Berlin, Mueller asked hi chief engineer to look into the matter. Hans Schmidt obtained several HDP units from Hudson Bay’s, and a minor R&D project was mounted to determine if the HDP could replace the Japanese control pack. Several weeks later, the following conversation occurred in Mueller’s office:

Schmidt: There’s no question that Hudson Hay’s HDP unit will work in our TCH—320. In fact, it could save us some money.
Mueller: That’s good news. If we can buy our components within the company, we’ll help Baltimore’s bottom line without hulling ours. Also, it will look good to the brass at corporate if they see us working hard to integrate our division into General Instrumentation’s overall production program.
Schmidt: I’ve also been worried about the reliability of supply of the control pack. I don’t like being dependent on such a critical supplier that way.
Mueller: I agree. Let’s look at your figures on the HDP replacement.
Schmidt: I got together with the controller’s people, and we worked up some numbers. I we replace the control pack with the HDP from Canada, we’ll avoid the $145 control pack cost we’re now incurring. In addition, I figure we’ll save $5.50 on the basic raw materials,
There is one catch, though. The HOP will require sonic adjustments in order to use it in the TCH—320. We can make the adjustments here in Berlin. I’m guessing it will require an additional two hours of skilled labor to make the necessary modifications. I don’t think variable overhead would be any different. Then there is the cost of transporting the HDPs to Berlin. Let’s figure on $4.50 per unit.
Mueller: Sounds good. I’ll give Jacqueline Ducharme a call and talk this over. We can use up to 10,000 of the HDP units per year given the demand for the TCH—320. I wonder what kind of a transfer price Hudson Bay will want.
Required:
1. Draw a simple diagram depicting the two divisions and their products. Also show the two alternatives that the Volkmar Tachometer Division has in the production of its TCH—320.
2. From the perspective of General Instrumentation’s top management, should any of the TCH—320 units be produced using the high-density panel? If so, how many?
3. Suppose hudson Bay transfers 10,000 HDP units per year to Volkmar. From the perspective of General Instrumentation’s top management, what effect will the transfer price have on the company’s income?
4. What is the minimum transfer price that the Hudson Buy Division would find acceptable for the HDP?
5. What is the maximum transfer price that the Volkmar Tachometer Division would find acceptable for the HDP?
6. As the corporate controller for General Instrumentation, recommend a transferprice.

Transcribed Image Text:

LDP HDP $ 5 $ 5 Unskilled labor (5 hour@$10) Skilled labor: LDP (25 hour @$20) 30 HDP (1.5 hours @$20) Raw material. Purchased components Variable overhead Total variable cost 12 15 $70 $22