A company has two divisions, Softwoods and Hardwoods, each operating as a profit center. The Softwood Division charges the Hardwood Division $35 per unit for each unit transferred to the Hardwood Division. Other data for the Softwood Division are as follows:
$$\begin{array} { l c c }
\text { Variable Cost per unit } & \$ 30 \
\text { Fixed Costs } & \$ 10,000 \
\text { Annual Sales to the Hardwood Division } & 5,000 \text { units } \
\text { Annual Sales to Outsiders } & 50,000 \text { units }
\end{array}$$
The Softwood Division is planning to raise its transfer price to $50 per unit. The Hardwood Division can purchase units at $40 per unit from outsiders but doing so would idle the Softwood Division's facilities (now committed to producing units for the Hardwood Division). The Softwood Division cannot increase its sales to outsiders. From the perspective of the company as a whole, from who should the Hardwood Division acquire the units, assuming the Hardwood Division's market is unaffected?
A) Outside vendors.
B) The Softwood Division, but only at the variable cost per unit.
C) The Softwood Division, but only until fixed costs are covered, then should purchase from outside vendors.
D) The Softwood Division, in spite of the increased transfer price.

Question

A company has two divisions, Softwoods and Hardwoods, each operating as a profit center. The Softwood Division charges the Hardwood Division $35 per unit for each unit transferred to the Hardwood Division. Other data for the Softwood Division are as follows:
$$\begin{array} { l c c } 
\text { Variable Cost per unit } & \$ 30 \
\text { Fixed Costs } & \$ 10,000 \
\text { Annual Sales to the Hardwood Division } & 5,000 \text { units } \
\text { Annual Sales to Outsiders } & 50,000 \text { units }
\end{array}$$
The Softwood Division is planning to raise its transfer price to $50 per unit. The Hardwood Division can purchase units at $40 per unit from outsiders but doing so would idle the Softwood Division's facilities (now committed to producing units for the Hardwood Division). The Softwood Division cannot increase its sales to outsiders. From the perspective of the company as a whole, from who should the Hardwood Division acquire the units, assuming the Hardwood Division's market is unaffected?
A) Outside vendors.
B) The Softwood Division, but only at the variable cost per unit.
C) The Softwood Division, but only until fixed costs are covered, then should purchase from outside vendors.
D) The Softwood Division, in spite of the increased transfer price.

Quizplus · Accepted Answer

The company as a whole is better off if the Hardwood Division continues to purchase from the Softwood Division, even at the increased transfer price of $50 per unit. This is because the Softwood Division's fixed costs are already covered by its sales to outsiders, so the only additional cost to the company is the variable cost of $30 per unit. The Hardwood Division would have to pay $40 per unit to purchase from outsiders, so the company saves $10 per unit by having the Hardwood Division continue to purchase from the Softwood Division.

A Company Has Two Divisions, Softwoods and Hardwoods, Each Operating