Wordsmith is a publishing company with several different book lines.

Wordsmith is a publishing company with several different book lines. Each line has contracts with different authors. The company also owns a printing operation called Pronto Press. The book lines and the printing operation each operate as a separate profit centre. The printing operation earns revenue by printing books by authors under contract with the book lines owned by Wordsmith, as well as authors under contract with other companies. The printing operation bills out at $1 per 100 pages, and a typical book requires 400 pages of print. A manager of Business Books, one of Wordsmith's book lines, has approached the manager of the printing operation and offered to pay $0.007 per page for 1,200 copies of a 400-page book. The book line pays outside printers $0.009 per page. The printing operation's variable cost per page is $0.006.

Instructions

(a) Determine whether the printing should be done internally or externally, and the appropriate transfer price, under each of the following situations:

1. Assume that the printing operation is booked solid for the next two years, and it would have to cancel an obligation with an outside customer in order to meet the needs of the internal division.

2. Assume that the printing operation has available capacity.

(b) The top management of Wordsmith believes that the printing operation should always do the printing for the company's authors. On several occasions, it has forced the printing operation to cancel jobs with outside customers in order to meet the needs of its own lines. Discuss the pros and cons of this approach.

(c) Calculate the change in contribution margin to each division, and to the company as a whole, if top management forces the printing operation to accept the $0.007 per page transfer price when it has no available capacity.

Contribution Margin
Contribution margin is an important element of cost volume profit analysis that managers carry out to assess the maximum number of units that are required to be at the breakeven point. Contribution margin is the profit before fixed cost and taxes...