Macon Motor Works Has Just Acquired a New Battery Division

Essay

Macon Motor Works has just acquired a new Battery Division. The Battery Division produces a standard 12-volt battery that it sells to retail outlets at a competitive price of $20. The retail outlets purchase about 800,000 batteries a year. Since the Battery Division has a capacity of 1,000,000 batteries per year, top management is thinking that it might be wise for the company's Automotive Division to start purchasing batteries from the newly acquired Battery Division.
The Automotive Division now purchases 300,000 batteries per year from an outside supplier at a price of $18 per battery. The discount from the competitive $20 price is a result of the large quantity purchased.
The Battery Division's cost per battery is shown below:
$$\begin{array} { l r } \text { Direct materials } & 8 \\\text { Direct labor } & 4 \\\text { Variable overhead } & 2 \\\text { Fixed overhead } & 2 \\ \text { Total cost } & \$ 16 \\\end{array}$$
Fixed costs are based on 1,000,000 batteries.
Both divisions are to be treated as investment centers, and their performance is to be evaluated by the ROI formula.
Required:
(a) What transfer price would you recommend and why?
(b) What transfer price would you recommend if the Battery Division is now selling 1,000,000 batteries a year to retail outlets?
(c) Suppose the manager of the Battery Division can increase its capacity to 1,500,000 units for $1,200,000. She then has the option of (c1) cutting the retail price to $17.50 with the certainty that sales will increase to 1,500,000 batteries, or (c2) maintaining the outside price of $20.00 for the 800,000 batteries and transferring the 300,000 batteries to the Automotive Division at some price that would produce the same income for the Battery Division as option (c1). What is the minimum transfer price you would recommend in the (c2) option?