Borkin Blue Carriage Inc. manufactures children's carriages. The carriages have a reputation for being high-quality and long lasting. They are built with a solid wood, steel handles, and 4 6-inch wheels. The quality of the wheels has attracted the attention of manufacturers in other industries such as trailer, lawn tractor, and wheelbarrow manufacturers. The company has grown significantly and now operates two manufacturing divisions: the Wheels Division and the Carriage Division.

Bob Barkerl, the CEO, is worried about whether the company is as profitable as it could be as he prepares the company for a private sale to an interested party.

The Wheels Division produces the wheels that are used by the Carriage Division to complete each carriage to be sold. The divisions are organized as cost centres and, as such, managers in each division are responsible for cost control and rewarded accordingly. Bonuses are based on their ability to adhere to standard product costs and to investigate and address variances. The wagons are sold to retailers for $250 each.

The standard cost and operating assets data for each division are as follows:

Wheels Division (per wheel):

Direct materials

$6.25

Direct labour

1.50

Variable overhead

0.90

*Fixed overhead

2.75

Operating assets

120,000

*Based on expected internal volume.

Carriage Division:

Wheels

?

Direct materials

85.00

Direct labour

25.00

Variable overhead

6.20

*Fixed overhead

18.00

Operating assets

340,000

*Based on expected internal volume.

For many years, the Wheels Division had been operating in a building just large enough to provide space and capacity sufficient for the required production volume (5,000 units). However, in anticipation of continued growth, the company recently added on to the manufacturing space and purchased additional production equipment. This year, the Wheels Division expects to be producing at 60% of the new capacity (i.e., twice the previous capacity) to meet internal demand.

Currently, wheels are provided to the Carriage Division at full cost. At a recent industry conference, Bob met a purchasing manager from a wheelbarrow manufacturer who was familiar with Bob's product. The purchasing manager informed Bob that he is buying the same size wheel, but at a lesser quality, for his product at a price of $11 per wheel. Bob also attended a workshop at the conference that discussed the pros and cons of decentralized decision-making in firms. Bob has returned from the conference and has plans to pursue some new ideas.

Required:

1.As currently operated (i.e., centralized cost centres), would the manager of the Wheels Division be interested in investigating the potential for external sales?

2.At what price are wheels currently transferred to the Carriage Division?

3.If the Wheels Division was run as a profit centre and you were the manager, would you be interested in selling externally at a price of $11 per wheel? Calculate the ROI with and without external sales. (Assume the Wheels Division is able to produce to capacity and sell all of the output at $11.)

4.What recommendations would you provide to Bob in terms of how his company could be organized to motivate his division managers to seek opportunities that will enhance company profits?

5.Calculate residual income for the entire company., assuming corporate fixed costs are $60,000 and the Wheels Division is able to sell externally at $12.50 and use all of its production capacity. Assume also that the company begins using a transfer price policy based on market price, has a minimum return requirement of 12%, and that there are no beginning or ending inventories.