Eastrise Corporation has two divisions: the Motor Division and the Mower Division. The Motor Division supplies the motors used by the Mower Division. The Mower Division produces approximately 10,000 mowers annually. Thus, it receives 10,000 motors from the Motor Division each year. The market price of these motors is $400. The total variable cost of the mower is $220 per unit. The market price of the mower is $600. The unit variable cost of each mower, excluding the cost of the motor, is $100.
The Motor Division is currently operating at full capacity, producing 30,000 motors per year (10,000 of which are transferred to the Mower Division). The demand for the motors is so great that all 30,000 units could be sold to outside customers if the Mower Division acquired its motors elsewhere. The Motor Division uses the full market price of $400 as the transfer price charged to the Mower Division.
The manager of the Mower Division asserts that the Motor Division benefits from the inter company transfers because of reduced advertising costs. As a result, he wants to negotiate a lower transfer price of $380 per unit.
a. Compute the contribution margin earned annually by each division and by the company as a whole using the current transfer price.
b. Compute the contribution margin that would be earned annually by each division and by the company as a whole if the discounted transfer price were used.
c. The transfer price charged to the Mower Division is $400, which is the market price of the motor. Why is manufacturing cost not a satisfactory transfer price for the Motor Division?