Reno Company is a decentralized company that has two divisions, Division A and Division B. Division A has the capacity to manufacture 24,000 units of a product that could be used by Division B. Division A currently is selling 16,000 units of the product to customers outside the company, incurring the following costs: variable costs of $7 per unit and total fixed costs of $48,000. The selling price to these customers is $16 per unit.Division B needs 4,000 units of the product that Division A makes. It currently is purchasing the units from an outside supplier at a price of $15 each. Division B offers to purchase the units from Division A at a price of $12; the managers of Division A say the price must be at least $14. The managers of the two divisions appear to have reached a stalemate,
which threatens to prevent the transfer from occurring within the company.Required:1) Is it in the best interest of Reno Company for Division B to purchase the units from Division A? Show quantitative support for your answer. 2) If the transfer is in the best interest of the company as a whole, should the top managers of Reno Company order the division managers to come to terms? How might the top management of Reno handle the situation other than by ordering the division managers to make the transfer?
What will be an ideal response?
Answers will vary
1) The best interests of Reno would be served by having the transfer occur internally. The variable costs for Division A ($7 per unit) should be compared to Division B's cost to purchase outside, $15. The company as a whole would be better off by $8 per unit, or $32,000 in total, for the transfer to occur internally. Division A's fixed costs are not relevant to the decision.
2) The top management of Reno Company probably should not force the two division managers to come to an agreement. Such an action would undermine the company's policy of decentralization and would perhaps diminish the morale of the managers of the divisions. The top management could perhaps arrange for the division managers to review the relevant accounting information. A negotiated price could benefit both divisions as well as the company as a whole.
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