Palmer Industries is a diversified corporation with separate operating divisions. Each division's performance is evaluated on the basis of profit and return on investment.

The KoolAir Division manufactures and sells air-conditioning units. The coming year's budgeted profit statement (please see attachments) is based on sales volume of 15,000 units.

The manager of the KoolAir Division believes that sales can be increased if the price of the air conditioners is reduced. Market research by an independent firm indicates that a 5 per cent reduction in the selling price would increase sales volume by 20 per cent, or 3000 units. KoolAir has sufficient production capacity to manage this increased volume with no increase in fixed costs.

KoolAir uses a compressor in its units, which purchases from an outside supplier at a cost of $140 per compressor. The division manager of KoolAir has asked the manager of the components division about selling compressor units to KoolAir. The components division currently manufactures and sells a compressor to outside firms, but the specifications of the KoolAir compressor are slightly different. Producing compressors to suit KoolAir's specifications would reduce direct material cost by $2 per unit. In addition, the components division would not incur any variable selling costs in the units sold to KoolAir. The manager of KoolAir wants all the compressors it uses to come from one supplier and has offered to pay $60 for each compressor unit.

The components division has capacity to produce 75,000 compressors. Its budgeted profit statement for the coming year, which follows, is based on a sales volume of 64,000 units, without considering KoolAir's proposal.