Conflict of Interests of Profit Centers and Company as a Whole |This and the next problem are adapted from David Solomons, Divisional Performance: Measurement and Control (New York: Financial Executives Research Foundation, 1965), pp. 167-79.] Division A of a company is the only source of supply for an intermediate product that is converted by Division B into a salable final product. Most of A’s costs are fixed. For any output up to 1,000 units a day, its total costs are $500 a day. Total costs increase by $100 a day for every additional thousand units made. Division A judges that its own results will be optimized if it sets its price at 40¢ a unit, and it acts accordingly.

Division B incurs additional costs in converting the intermediate product supplied by A into a finished product. These costs are $1,250 for any output up to 1,000 units, and $250 per thousand for outputs in excess of 1,000. On the revenue side, B can increase its revenue only by spending more on sales promotion and by reducing selling prices. Its sales forecast is:

NET REVENUE PER SALES IN UNITS THOUSAND UNITS 1,000 $1,750.00 2,000 1,325.00 3,000 1,100.00 4,000 925.00 5,000 800.00 6,000 666.67 1. Prepare a schedule comparing B’s costs, including its purchases from A, revenues, and net income at various levels of output.
2. What is B’s maximum net income? At that level, what is A’s net income?
At that level, what is the corporation’s aggregate net income?
3. Suppose the company abandons its divisionalized structure. Instead of being two profit centers, A and B are combined into a single profit center with responsibility for the complete production and marketing of the product.
Prepare a schedule similar to that in requirement 1. What volume level will provide the most net income?
4. Evaluate the results in 3. Why did the circumstances in requirement 1 lead to less net income than in requirement 3? How would you adjust the transferpricing policy to assure that overall company net income will be maximized where separate profit centers A and B are maintained? lop1