Question 2 (15 marks) Green Co. is a decentralized company consisting of several strategic business units (divisions). The Yellow Division (YD) makes one product, the YT-100, which it sells in the industrial markets. The product had been highly successful and the division usually operates at capacity. In fact, demand now exceeds the division's ability to supply product due to insufficient machine capacity. The Blue Division (BD) was formed a few years ago to take advantage of a new market segment, with a product known as the BD-900. The division has had slow growth over its first three years, as anticipated, but is now close to a breakthrough in terms of market share. A prominent customer in the field has asked the Blue Division to quote on a significant order that could set the division on a path to more consistent profitability. Green Co. uses an investment centre approach and uses return on investment (ROI) to measure management performance. A significant portion of the incentive compensation paid to managers is based upon a division's ability to increase ROl from one year to the next. Exhibit one contains financial information for the YT-100. The market for the product is growing, but is very competitive. The Yellow Division is not a market leader and competes on the basis of selling price and product quality. Variable selling and administration costs are estimated to be 12% of the unit selling price. The Blue Division has been profitable but has not developed its market share as quickly as the corporate head office had hoped. The opportunity to quote on business with a new customer is seen as a sign of significant progress. The order will potentially increase production by 25,000 units. Financial information on the BD-900 is included in Exhibit two. One significant compaonent of the BD-900 that is currently provided by an outside supplier can be replaced by using a modified version of the YT-100. The modifications would increase the labour cost by 10% and would add $5.00 per unit to the cost of the material. It would take 0.5 hours of machine time to make the modified YT-100. The modified unit would replace a component currently purchased from an outside supplier for $35.00. Variable selling and administration costs will not apply to any internal transfers. Management of the Blue Division believes the new order will have to be priced at $100.00 per unit in order to obtain the business. They also believe that fixed manufacturing costs and selling and administrative costs will each increase by $100,000. Sales commission, based on 12% of the unit selling price, will be applicable to the order. Green Co. Yellow Division Exhibit One Product Information for the YT-100 Volume 200,000 Unit selling price $30.00 Variable costs Direct materials 7.00 Direct labour 5.00 Overhead 5.00 Selling &administration 3.60 Fixed costs Manufacturing $400,000 Selling & administration 400,000 Machine time per unit 0.4 hours per unit Variable overhead cost per hour $12.50 Production volume as a % of capacity 100% Green Co. Blue Division Exhibit Two Product Information for the BD-900 Volume 100,000 Unit selling price $105.00 Variable costs Direct materials = YT-100 equivalent 35.00 Direct materials other 25.00 Direct labour 6.00 Overhead 7.00 Selling &administration (12% of unit selling price) 12.60 Fixed costs Manufacturing $600,000 Selling & administration 400,000 Production volume as a % of capacity 50% Required: 1. Assume that the Yellow Division management is not interested in making the modified YT-100 for internal transfer to the Blue Division. From the perspective of the company as a whole, should the Blue Division purchase the component externally and quote on the new business? Provide quantitative support, including a calculation of the incremental income that the Blue Division would generate from the new order. Current sales will not be affected by the new order. The selling price of $100.00 will apply to the new order only. (6 marks) Now assume the Yellow Division is willing to produce 25,000 units of the modified YT-100 for Blue Division's special order. From the perspective of the company as a whole, what is the incremental operating income related to the special order if the modified YT-100 is transferred internally? (6 marks) Assume you are the manager of the Yellow Division. What is the minimum price that you are willing to accept from the Blue Division for the modified YT-1007