The Assembly Division of American Car Company has offered to purchase 90,000 batteries from the Electrical Division

Fantastic news! We've Found the answer you've been seeking!

Question:

The Assembly Division of American Car Company has offered to purchase 90,000 batteries from the Electrical Division of American Car for $100 per unit. At a normal volume of 250,000 batteries per year, production costs per battery are as follows:

Direct materials	$ 40
Direct manufacturing labor	20
Variable factory overhead	12
Fixed factory overhead	40
Total	$112

The Electrical Division has been selling 250,000 batteries per year to external buyers at $136 each; practical capacity is 340,000 batteries per year. If Assembly Division does not buy internally, then it will buy batteries from external sources for $130 each.

Will Electrical Division’s total operating income be higher or lower if it accepts the offer from Assembly Division? By how much?

Will American Car Company’s total operating income be higher or lower—and by how much—if Electrical Division accepts the offer, rather than rejecting it and forcing Assembly Division to buy the batteries from external sources?

Now suppose that Electrical Division has created a new product. Demand for this product would be sufficient to occupy the capacity which has been unused in the recent past and which might be used to supply batteries to Assembly. Electrical could produce and sell 90,000 units of this new product to external customers for a price of $98 per unit without reducing its current external battery sales of 250,000 units or changing its total fixed costs. Variable manufacturing costs for the new product would be $54 per unit. Is it better for American Cars if (a) Electrical Division makes the new product or (b) it uses the capacity to produce batteries for Assembly Division? By how much would American Car’s total contribution margin differ depending on whether (a) or (b) is chosen?

Given the information in question 3, what is the maximum transfer price that Assembly Division would be willing to pay and the minimum transfer price that Electrical Division would be willing to accept for the batteries?

If the division managers of the two divisions are left to negotiate the price, then is it likely that they will make the decision about internal trade that is best for American Cars? Explain briefly.