QUESTION 22 (24 Marks)

Halibut Co. Ltd. Has two division: Essex and York. The two divisions are considered to be investment centres and are evaluated based on return on investment. In determining the value of invested capital, the company uses the net book value of total assets employed. Current assets usually average 10% of annual sales. The non-current assets of Essex Division currently have a net book value of $400,000, and the non-current assets of York Division have a net book value of $2,000,000. The combined total for Halibut is $2,400,000.

Essex Division produces and sells electronic timers, and has been operating considerably below capacity. The selling price per timer is $34. The standard cost breakdown for one timer at the current annual normal activity of 60,000 timers is as follows:

Direct material	$12.00
Direct labor (@ $9/hr)	9.00
Variable overhead (@ $3/DLH)	3.00
Fixed overhead	5.00
Fixed selling and general	3.50
Total cost	$32.50

One major material component for the timer is purchased form an outside source for $7.50 each. This component can be replaced by an assembly (assembly #AC18) which is produced by York Division. In order to use this assembly, Essex Division would have to spend an additional 5 minutes of production time per timer for modification.

York Division produces an engine regulator in which assembly #AC18 is used. Standard costs for the production and sale of assemblies and regulators are based on York Divisions current annual normal activity of 180,000 regulators. Maximum annual capacity is 144,000 production hours or 192,000 regulators. The unit standard cost breakdown for assemblies and finished regulators produced by York Division is as follows:

	Assembly #AC18	Regulator
Direct material	$1.50	$4.00*
Direct labor	2.25	6.75*
Variable overhead	0.75	2.25*
Fixed overhead	1.50	4.50*
Fixed selling and general	-	1.50
Total cost		$19.00
Production time (minutes)	15	45*

* Includes the cost and production time of one assembly.

The selling price of one regulator is $21. The manger of York Division is interested in supplying assembly #AC18 to Essex Division and is willing, given a suitable transfer price, to switch some production time from regulators to assemblies

REQUIRED:

a) Calculate the effect of the following on Halibut Co. Ltd.s overall annual net income:

i) York Division uses only its excess capacity to produce assemblies for Essex Division.

ii) York Division supplies all the assemblies required by Essex Division.

b)

i)	Calculate the minimum unit transfer price acceptable to York Division for assemblies produced using only its excess capacity, assuming that York Division wishes to earn a 25 percent contribution margin ratio on transferred assemblies.
ii)	Calculate the minimum unit transfer price acceptable to York Division if it supplies all the assemblies required by Essex Division, assuming York Division wishes to maintain its current level of net income.
iii)	Calculate the maximum unit transfer price acceptable to Essex Division.

c)	Assume that a transfer price of $6.25 per assembly is negotiated by York and Essex for all of Essex Divisions requirements. Briefly explain the impact of this agreement on the return on investment for each of the following:

i)	Essex Division
ii)	York Division
iii)	Halibut Company Ltd. as a whole.

Support your answers with calculations.