Differential Costing and Transfer Pricing Decisions: National Industries is a diversified corporation with separate operating divisions. Each division's performance is evaluated on the basis of total operating profits and return on division investment. The WindAir division manufactures and sells air-conditioner units. Next year's budgeted income statement, based on a sales volume of 15,000 units, appears below.

WindAir's division manager believes sales can be increased if the unit selling price of the air conditioners is reduced. A market research study indicates that a 5 percent reduction in the selling price ($20) would increase sales volume 16 percent, or 2,400 units. WindAir has sufficient production capacity to manage this increased volume with no increase in fixed costs. Wind Air presently uses a compressor in its units that it purchases from an outside supplier at a cost of $70 per compressor. The division manager of WindAir ap- proached the manager of the compressor division regarding the sale of a compressor unit to WindAir. The compressor division currently manufactures and sells a unit exclusively to outside firms that is similar to the unit used by WindAir. The specifica- tions of the WindAir compressor are slightly different, which would reduce the compressor division's direct material cost by $1.50 per unit. The compressor division would not incur any variable selling costs in the units sold to WindAir. The manager of WindAir offered to pay $50 for each compressor unit purchased from the com- pressor division. The compressor division has the capacity to produce 75,000 units. The coming year's budgeted income statement for the compressor division is shown below and is based on a sales volume of 64,000 units without considering WindAir's proposal.

Required:

a. Should WindAir division institute the 5 percent price reduction on its air-condi- tioner units even if it cannot acquire the compressors internally for $50 each? Support your conclusions with appropriate calculations.

b. Regardless of your answer to requirement a.. assume WindAir needs 17.400 units. Should the compressor division be willing to supply the compressor units for $50 each? Support your conclusions with appropriate calculations.

c. Regardless of your answer to requirement a., assume WindAir needs 17,400 units. Would it be in the best interest of National Industries for the compressor division to supply the compressor units at $50 each to the WindAir division? Support your conclusions with appropriate calculations.

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WINDAIR DIVISION Budgeted Income Statement For Next Year Per Total Unit (in thousands) Sales revenue Manufacturing costs: Compressor Other direct materials Direct labor Variable overhead Fixed overhead Total manufacturing costs Gross margin Operating costs: Variable marketing Fixed marketing Fixed administrative Total operating costs $400 $6,000 1,050 555 285 570 1,125 Operating profit before taxes $1,665 88 450 675 480 3,210 2,790 270