Petro Refinery, Inc., located in Houston, TX, has separate divisions for “Unleaded Gasoline” and “Jet Fuel”.

 

The variable costs are as follows:

 

■ Unleaded Gasoline division: $1.75 per gallon of unleaded gasoline

■ Jet Fuel division: $1.95 per gallon jet fuel

 

Assume that there is no loss in processing unleaded gasoline into jet fuel. Unleaded Gasoline can be sold at $2.25 per gallon. Jet Fuel can be sold at $3.95 per gallon.

 

Required:

 

1. Should Petro Refinery process the unleaded gasoline into its jet fuel? Show your calculations. Explain.

 

2. Assume that Petro Refinery headquarters requires that the internal transfers are made at 130% of variable cost. What would be your reaction to this policy as the division manager for Unleaded Gasoline? Is this action in the best interest of Petro Refinery as a whole? Explain.

 

3. Assume that internal transfers are made at market prices. Will each division maximize its division operating-income contribution by adopting the action that is in the best interest of Petro Refinery as a whole? Explain.