Crispy Clothes Ltd has several operating divisions, all of which are run separately as investment centres. Two of its divisions are the Condenser Division (Condenser), which manufactures and sells condenser tumble dryers, and the Heating Division (Heating), which makes Heat Exchangers. Below is Condenser's budgeted profit statement for the coming year, which is based on a sales volume of 15,000 units. Condenser has capacity to produce 20,000 units. A key component of the condenser tumble dryers is a heat exchanger. These are currently purchased externally at $280 per unit. Below is Heating's budgeted profit statement for the coming year, which is based on a sales volume of 64,000 units. Heating has capacity to produce 75,000 heat exchangers. The specifications of the heat exchangers that Heating makes are slightly different to the ones that Condenser uses, and so far Heating has been selling all of its heat exchangers externally. Heating Division Budgeted Profit Statement Condenser's manager recently engaged an independent firm to conduct market research into the likely impact of a sales price reduction on demand. The research indicated that a 5% reduction in selling price will increase sales volume by 20 per cent, or 3,000 units. Condenser has sufficient excess capacity and can produce this higher volume without any increase in fixed costs. After learning the above, Condenser's manager approached Heating's manager, and asked if they would sell heat exchangers internally to them, as Condenser's manager wants all heat exchangers to come from one supplier. Condenser's manager offered to pay $120 for each unit, and pointed out that the slightly different specifications would mean that Heating's direct material costs would be reduced by $4 per unit. In addition, Heating wouldn't have to worry about variable selling costs for these units, due to the internal sale. Note: key answers are provided to requirements 1-4 to help you progress through the question with confidence. When performing your calculations, it is helpful to think about what costs and revenues will change under each scenario, and which ones won't. The "Transfer pricing under different scenarios" section in your readings may help you think through how to approach the question). 1. Assuming that the market research is accurate, should Condenser reduce sales price by 5%, even if it has to buy all 18,000 heat exchangers externally? Provide calculations in support of your answer. (Net profit increases by $960,000 with the price reduction) 2. Do you think Heating would be willing to supply 18,000 heat exchangers at $120 each? (in answering this section you can ignore your answer to requirement 1). Provide calculations in support of your answer. (Heating profit would decrease by $172,000 if price is set at $120 ) 3. What transfer price would be set for each heat exchanger unit if the general transfer pricing rule is used? Provide calculations in support of your answer. ( Transfer price =$129.56( rounded to 2 decimal places )). 4. Prepare budgeted profit statements for Heating, Condenser, and Crispy Clothes Ltd if Heating: a. Decides to sell the heat exchangers to Condenser based on the transfer price you calculated in requirement 3 ; or b. Decides not to sell the heat exchangers to Condenser, forcing Condenser to purchase the 18,000 units externally. 4a. Net profit: Heating $2,944,080 (or $2,944,000 without rounding), Condenser $10,327,920 (or $10,328,000 without rounding), Crispy Clothes $13,272,000. 4b. Net profit: Heating $2,944,080, Condenser $7,620,000, Crispy Clothes $10,564,000. 5. Assume that Heating's manager's bonus is based on divisional profit. Will Heating's manager make a "goal congruent" decision if Crispy Clothes requires that the transfer price be set using the general transfer pricing rule (use your answers to requirements 3 and 4 to inform your answer here)? 6. Assume instead that Crispy Clothes requires divisions to adopt a "negotiated price" approach to setting transfer prices, and that Heating and Condenser managers need to negotiate a price for the heat exchangers. What range would the transfer price have to fall within in order for it to be acceptable to both divisions? Explain your answer. 7. Even if a seemingly acceptable transfer price is offered to Heating, what other considerations or concerns might Heating have before agreeing to supply units to Condenser? Crispy Clothes Ltd has several operating divisions, all of which are run separately as investment centres. Two of its divisions are the Condenser Division (Condenser), which manufactures and sells condenser tumble dryers, and the Heating Division (Heating), which makes Heat Exchangers. Below is Condenser's budgeted profit statement for the coming year, which is based on a sales volume of 15,000 units. Condenser has capacity to produce 20,000 units. A key component of the condenser tumble dryers is a heat exchanger. These are currently purchased externally at $280 per unit. Below is Heating's budgeted profit statement for the coming year, which is based on a sales volume of 64,000 units. Heating has capacity to produce 75,000 heat exchangers. The specifications of the heat exchangers that Heating makes are slightly different to the ones that Condenser uses, and so far Heating has been selling all of its heat exchangers externally. Heating Division Budgeted Profit Statement Condenser's manager recently engaged an independent firm to conduct market research into the likely impact of a sales price reduction on demand. The research indicated that a 5% reduction in selling price will increase sales volume by 20 per cent, or 3,000 units. Condenser has sufficient excess capacity and can produce this higher volume without any increase in fixed costs. After learning the above, Condenser's manager approached Heating's manager, and asked if they would sell heat exchangers internally to them, as Condenser's manager wants all heat exchangers to come from one supplier. Condenser's manager offered to pay $120 for each unit, and pointed out that the slightly different specifications would mean that Heating's direct material costs would be reduced by $4 per unit. In addition, Heating wouldn't have to worry about variable selling costs for these units, due to the internal sale. Note: key answers are provided to requirements 1-4 to help you progress through the question with confidence. When performing your calculations, it is helpful to think about what costs and revenues will change under each scenario, and which ones won't. The "Transfer pricing under different scenarios" section in your readings may help you think through how to approach the question). 1. Assuming that the market research is accurate, should Condenser reduce sales price by 5%, even if it has to buy all 18,000 heat exchangers externally? Provide calculations in support of your answer. (Net profit increases by $960,000 with the price reduction) 2. Do you think Heating would be willing to supply 18,000 heat exchangers at $120 each? (in answering this section you can ignore your answer to requirement 1). Provide calculations in support of your answer. (Heating profit would decrease by $172,000 if price is set at $120 ) 3. What transfer price would be set for each heat exchanger unit if the general transfer pricing rule is used? Provide calculations in support of your answer. ( Transfer price =$129.56( rounded to 2 decimal places )). 4. Prepare budgeted profit statements for Heating, Condenser, and Crispy Clothes Ltd if Heating: a. Decides to sell the heat exchangers to Condenser based on the transfer price you calculated in requirement 3 ; or b. Decides not to sell the heat exchangers to Condenser, forcing Condenser to purchase the 18,000 units externally. 4a. Net profit: Heating $2,944,080 (or $2,944,000 without rounding), Condenser $10,327,920 (or $10,328,000 without rounding), Crispy Clothes $13,272,000. 4b. Net profit: Heating $2,944,080, Condenser $7,620,000, Crispy Clothes $10,564,000. 5. Assume that Heating's manager's bonus is based on divisional profit. Will Heating's manager make a "goal congruent" decision if Crispy Clothes requires that the transfer price be set using the general transfer pricing rule (use your answers to requirements 3 and 4 to inform your answer here)? 6. Assume instead that Crispy Clothes requires divisions to adopt a "negotiated price" approach to setting transfer prices, and that Heating and Condenser managers need to negotiate a price for the heat exchangers. What range would the transfer price have to fall within in order for it to be acceptable to both divisions? Explain your answer. 7. Even if a seemingly acceptable transfer price is offered to Heating, what other considerations or concerns might Heating have before agreeing to supply units to Condenser