Appropriate Transfer Prices: Opportunity Costs Plains Peanut Butter Company recently acquired a peanut-processing company that has a normal annual capacity of 4,000,000 pounds and that sold 2,700,000 pounds last year at a price of $2.00 per pound. The purpose of the acquisition is to furnish peanuts for the peanut butter plant, which needs 1,700,000 pounds of peanuts per year. It has been purchasing peanuts from suppliers at the market price. Production costs per pound of the peanut-processing company are as follows:

Direct materials	$0.50
Direct labor	0.23
Variable overhead	0.14
Fixed overhead at normal capacity	0.20
Total	$1.07

Management is trying to decide what transfer price to use for sales from the newly acquired Peanut Division to the Peanut Butter Division. The manager of the Peanut Division argues that $2.00, the market price, is appropriate. The manager of the Peanut Butter Division argues that the cost price of $1.07 (or perhaps even less) should be used since fixed overhead costs should be recomputed. Any output of the Peanut Division up to 2,700,000 pounds that is not sold to the Peanut Butter Division could be sold to regular customers at $2.00 per pound. (a) Compute the annual gross profit for the Peanut Division using a transfer price of $2.00. $Answer

(b) Compute the annual gross profit for the Peanut Division using a transfer price of $1.07.

$

Answer

2. ROI and Residual Income: Basic Computations Watkins Associated Industries is a highly diversified company with three divisions: Trucking, Seafood, and Construction. Assume that the company uses return on investment and residual income as two of the evaluation tools for division managers. The company has a minimum desired rate of return on investment of 10 percent with a 30 percent tax rate. Selected operating data for three divisions of the company follow.

Sales	$ 1,200,000	$ 750,000	$ 900,000
Operating assets	600,000	250,000	350,000
Net operating income	116,000	66,000	63,000

(a) Compute the return on investment for each division. (Round answers to three decimal places.)

Trucking ROI =	Answer
Seafood ROI =	Answer
Construction ROI =	Answer

(b) Compute the residual income for each division.

Net operating income	$Answer	$Answer	$Answer
Minimum level	Answer	Answer	Answer
Residual income	$Answer	$Answer	$ Answer