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From the point of view of the managing director of AB Company, what price should Division B charge for XK120, and what volume should be sold in order to maximise return on investment for the company as a whole?

05 / 03 / 2018 Assignment

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AB Company specialises in electronic products. Division A makes integrated circuits and sells 90% of its output to outside companies. This division is operating well below capacity.

Division B has developed a new product codenamed XK120 that could use the circuit made by Division A. The manager of Division A has quoted a transfer price of $80 per circuit, which is below the current market price, and which would provide a $40 contribution margin.

The accountant of Division B has provided the following estimates of costs for XK120:

Materials, including $80 for one circuit $200
Direct labour 20
Factory overhead* 80
Selling and administrative expenses** 20
Total cost $320

* $40 fixed, $40 variable
** $10 fixed, $10 variable

The marketing manager of Division B has submitted the following estimates of their demand schedule for XK120:

Price Demand (units)
$400 4,000
325 6,000
300 9,000
250 12,000

Division A has enough capacity to meet the 12 000 maximum volume that Division B could obtain.

Divisional managers are evaluated on ROI, and total investment would be the same for any of the volumes that Division B may sell.

(a) As the manager of Division B, given the transfer price of $80, what price would you charge for XK120 and what volume would you sell? (3 marks)

(b) Given the price calculated in (a), what total contribution would be earned by:
(i) Division A?
(ii) Division B?
(2 marks)

(d) From the point of view of the managing director of AB Company, what price should Division B charge for XK120, and what volume should be sold in order to maximise return on investment for the company as a whole? (2 marks)


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