Thai Company has two divisions organized as profit centers: Redmon and Tomlin. Thai expects the following results in the coming period: Redmon TomlinSales Redmon: (10,000 × $16)$1,600,000 Tomlin: (250,000 × $7.20) $1,800,000 Variable costs 1,360,000 1,000,000 Contribution margin$240,000 $800,000 Fixed costs 160,000 460,000 Profit$80,000 $340,000 Included in Redmon's costs are 100,000 units of a subcomponent purchased from an outside supplier for $4.50 per unit. The managers have recently initiated negotiations for Tomlin to supply the components to Redmon. Tomlin has a total capacity of 400,000 units.Required:(a) Would Thai Company prefer the subcomponent used by Redmon to be purchased internally from Tomlin or from the outside
vendor? What would be the profit impact of this decision?(b) What would be the maximum and minimum transfer prices?
What will be an ideal response?
(a)
The internal cost is the variable cost of $4 per unit ($1,000,000/250,000 units). The external price is $4.50 per unit. Thai Company would prefer that the subcomponent be purchased internally. The profit impact of purchasing internally would be an increase of $50,000 [(100,000 units × ($4.50 ? $4)].
(b)
The maximum transfer price is the market (outside) price of $4.50 per unit. The minimum transfer price is the variable cost of $4 per unit.
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