Accounting for Decision Making and Control 7th Edition by Jerold Zimmerman

Exercise 27

Cogen
Cogen's Turbine Division manufactures gas-powered turbines for generating electric power and hot water for heating systems. Turbine's variable cost per unit is $150,000 and its fixed cost is $1.8 million per month. It has excess capacity. Cogen's Generator Division buys gas turbines from Cogen's Turbine Division and incorporates them into electric steam generating units. Both divisional managers are evaluated and rewarded as profit centers.
The Generator Division has variable cost of $200,000 per completed unit, excluding the cost of the turbine, and fixed cost of $1.4 million per month. The Generator Division faces the following monthly demand schedule for its complete generating unit (turbine and generator): Required:
a. If the transfer price of turbines is set at Turbine's variable cost ($150,000), how many turbines will the Generator Division purchase to maximize its profits?
b. The Turbine Division expects to sell a total of 20 turbines a month, which includes both external and internal sales. Calculate the (average) full cost of a turbine (fixed cost plus variable cost) at this level of sales.
c. If the transfer price of turbines is set at Turbine's (average) full cost calculated in (b), how many turbines will the Generator Division purchase?
d. Should Cogen use a variable-cost transfer price or a full-cost transfer price to transfer turbines between the Turbine and Generator divisions? Why?