Pebble Beach Sandals has designed and patented a luxury golf sandal for both men and women. The unique handmade designs include spikes and cleats to prevent the golfer from slipping during the swing. The sandal is made from sheepskin, creating comfortable and distinctive footwear sold directly to wholesalers who then sell them to exclusive golf shops for retail prices starting at $ 400.

The sandals are manufactured in the United States and sold in the United States and Europe through two dedicated sales divisions. The United States and EU sales divisions are organized as separate profit centers with decision rights to set prices in their respective geographic territories. The U. S. factory is a cost center that produces the sandals and transfers them to the two sales divisions. Each sales division is charged the full manufacturing cost of the sandals (direct labor, direct materials, and overhead). All the sandals produced, both men’s and women’s styles, and all the various models contain similar amounts of direct labor and direct material. The only difference between the U. S. and EU sandals is the sizing and the size labels stitched into the sandals. Hence, volume in the plant is measured as pairs of sandals manufactured.

This year’s manufacturing cost of Pebble Beach sandals is given by the following table:

Direct labor............... $ 38

Direct material............... 44

Variable overhead............... 9

Allocated fixed manufacturing overhead*... 39

Total cost................ $ 130

The U. S. plant was built with a capacity to produce between 16,000 and 20,000 sandals per year and a long- run expected volume of 18,000 sandals.

The U. S. sales division faces the following demand curve for sandals: 2

Price Quantity

$ 260........... 7,200

255 ...........7,600

250 ...........8,000

245 ...........8,400

240 ...........8,800

235 ...........9,200

Besides paying the manufacturing plant’s transfer cost of the sandals ($ 130 per pair), the U. S. sales division has its own variable costs of $ 20 per pair and incurs fixed costs per year of $ 700,000.

Required:

a. In order to maximize its own profits (after paying the manufacturing plant’s transfer cost of $ 130), how many pairs of sandals will the U. S. sales division order and expect to sell this year? Show calculations.

b. Next year, the U. S. sales division expects its variable costs per pair to remain at $ 20 and its fixed costs to remain at $ 700,000 per year. However, due to a sharp reduction in EU demand caused by a recession, the projected combined demand from the U. S. and EU sales divisions for sandals falls from the current level of 17,400 sandals to 14,200. The plant’s budgeted direct labor, direct materials, variable overhead, and fixed overhead will remain the same as this year’s amounts, but the allocated fixed overhead per pair of sandals will rise due to the lower projected volumes. Compute next year’s allocated fixed manufacturing overhead per pair of sandals and the total cost that will be used as the transfer cost based on next year’s projected volume. (Round all costs to the nearest dollar.)

c. Using the transfer cost you computed in part (b ), how many pairs of sandals will the U. S. sales division order next year? Show calculations.

d. Does the number of pairs of sandals ordered by the U. S. sales division maximize the profits (net cash flows) of Pebble Beach Sandals? Explain why or why not.

e. What suggestions would you offer management to increase Pebble Beach Sandals’ shareholder value?