Kick and Rush plc produces footballs for various amateur leagues in South-East England. They consist of two divisions, the leather division which cuts and waterproofs the leather, and the stitching division, which sews the leather together, inserts an air bladder, and sells the footballs to the various league.The leather division prepares the leather in the correct size per football, and charges a transfer price of £17 per unit to the stitching division. This price is based on the current market price for very large wholesale orders less selling and distribution costs which are not applicable in the case of internal transfers. These costs are variable and amount to £3 per unit. The leather division also has access to the external market, where it sells their prepared leather for £20 per (equivalent) unit. These external sales, however, only account for 20 per cent of their total sales volume of 12,000 units per year. The summarized financial details for the leather division for the last year are as follows:

Recently, the English branch of a German leather processing company, Wildleder plc, has approached the stitching division with a leather product similar in quality for £15 per unit. The director of the stitching division, Charles Valiant-Tailor, now wants to stop all internal purchases and to obtain the required leather from Wildleder plc. The division manager of the leather division Linda Shagreen however, states that this price is not feasible for her division to match and that they would not be able to recover more than 33 per cent of the lost internal sales externally. The performance of both divisions is measured on the basis of profit generated and neither director is willing to give way on this issue. Headquarters need to step in and resolve the situation.

Required: 

a) Appraise the situation after the offer of Wildleder plc, taking into account the changes in profit and costs, and consider the financial impact on the company.

b) Headquarters suggest using the same transfer price as the price offered by Wildleder plc. Analyse the outcomes of this suggestion, and decide if they are better off compared to the initial scenario and the scenario where the leather division would lose their internal sales. Consider the financial impact on Kick and Rush plc if they go forward with this suggestion.

c) Critically interpret the results

 

Leather division Sales Variable costs Contribution Fixed costs Net profit/(loss) 12,000 x 80% x 17 12,000 x 80% x 12 Internal 163,200 (115,200) 48,000 12,000 x 20% x 20 12,000 x 20% x 15 External 48,000 (36,000) 12,000 Total 211,200 (151,200) 60,000 (35,000) 25,000