Sandia, Inc., manufactures radios, televisions, and VCRs in its four divisions: Radio, TV, VCR, and Components. The Components Division produces electronic components that can be used by the other three. All the components produced by this division can be sold to out¬

side customers; however, from the beginning, about 70% of its output has been used inter¬

nally. The current policy requires that all internal transfers of components be transferred at full cost.

Recently, Jasper Ferguson, the new chief executive officer of Sandia, decided to inves¬

tigate the transfer pricing policy. He was concerned that the current method of pricing in¬

ternal transfers might force decisions by divisional managers that would be suboptimal for the firm. As part of his inquiry, he gathered some information concerning Component 12F, used by the Radio Division in its production of a clock radio. Model 357K.

The Radio Division sells 100,000 units of Model 357K each year at a unit price of $21.

Given current market conditions, this is the maximum price that the division can charge for Model 357K. The cost of manufacturing the radio is:

The radio is produced efficiently and no further reduction in manufacturing costs is possible.
The manager of the Components Division indicated that she could sell 100,000 units (the division's capacity for this part) of Component 12F to outside buyers at $12 per unit.
The Radio Division could also buy the part for $12 from external suppliers. She supplied the following detail on the manufacturing cost of the component:

Required:
1. Compute the firmwide contribution margin associated with Component 12F and Model 357K. Also, compute the contribution margin earned by each division.
2. Suppose that Jasper Ferguson abolishes the current transfer pricing policy and gives di¬
visions autonomy in setting transfer prices. Can you predict what transfer price the manager of the Components Division will set? What should be the minimum transfer price for this part? The maximum?
3. Given the new transfer pricing policy, predict how this will affect the production decision for Model 357K of the manager of the Radio Division. How many units of Component 12F will the manager of the Radio Division purchase, either internally or externally?
4. Given the new transfer price set by the Components Division and your answer to Re¬
quirement 3, how many units of 12F will be sold externally?
5. Given your answers to Requirements 3 and 4, compute the firmwide contribution mar¬
gin. What has happened? Was Jasper's decision to grant additional decentralization good or bad?

Transcribed Image Text:

Component 12F Direct materials Direct labor Variable overhead $ 7 6 3 1 Fixed overhead 2 Total unit cost $19