CASE 13-51 (45 minutes)

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Answer:

Yes, Air Comfort Division should institute the 5% price reduction on its air conditioner units
because net income would increase by $132,000. Supporting calculations follow:

Before 5% After 5%
Price Reduction Price Reduction
Total
Per Total Per Total Difference
Unit (in thousands) Unit (in thousands) (in thousands)
Sales revenue $400 $6,000 $380 $6,612.0 $612.0
Variable costs:
Compressor  $ 70 $1,050 $70  $1,218.0 $168.0
Other direct material 37 555 37 643.8 88.8
Direct labor  30   450   30   522.0 72.0
Variable overhead 45   675   45   783.0 108.0
Variable selling  18   270   18   313.2   43.2  
Total variable costs $200 $3,000 $200 $3,480.0 $480.0
Contribution margin $200 $3,000 $180 $3,132.0 $132.0

Summarized presentation:

Contribution margin of sales increase ($180 ´ 2,400)............................. $432,000

Loss in contribution margin on original volume arising from
decrease in selling price ($20 ´ 15,000)……………………………………..
300,000 

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 Increase in net income before taxes………………………………………
$132,000

No, the Compressor Division should not sell all 17,400 units to the Air Comfort Division for
$50 each. If the Compressor Division does sell all 17,400 units to Air Comfort, Compressor
will only be able to sell 57,600 units to outside customers instead of 64,000 units due to the
capacity restrictions. This would decrease the Compressor Division’s net income before taxes
by $35,500. Compressor Division would be willing to accept any orders from Air Comfort
above the 64,000 unit level at $50 per unit because there would be a positive contribution
margin of $21.50 per unit. Supporting calculations follow.

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CASE 13-51 (Continued)
Outside Air Comfort
Sales Sales
Selling price $100 $50.00
Variable costs: 
Direct material 12  $10.50
Direct labor 8    8.00
Variable overhead   10   10.00
Variable selling expenses 6        —     
Total variable costs $ 36  $28.50
Contribution margin $ 64  $21.50

Capacity calculation in units:

Total capacity 75,000

Sales to Air Comfort 17,400
Balance 57,600
Projected sales to outsiders 64,000
Lost sales to outsiders 6,400 

Solution:

Contribution from sales to Air Comfort ($21.50  ´ 17,400) $374,100

Loss in contribution from loss of sales to outsiders ($64  ´ 6,400) 409,600 
Decrease in net income before taxes $ 35,500 

Yes, it would be in the best interests of InterGlobal Industries for the Compressor Division to
sell the units to the Air Comfort Division at $50 each. The net advantage to InterGlobal
Industries is $312,500 as shown in the following analysis. The net advantage is the result of
the cost savings from purchasing the compressor unit internally and the contribution margin
lost from the 6,400 units that the Compressor Division otherwise would sell to outside
customers.

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CASE 13-51 (Continued)
Cost savings by using compressor unit from Compressor Division:

Compressor Division: 
Air Comfort Division’s outside purchase price $ 70.00 
Compressor Division’s variable cost to produce (see req. 2). 28.50 
Savings per unit $ 41.50
x Number of units x
17,400 
Total cost savings $722,100
Compressor Division’s loss in contribution from loss
of sales to outsiders (see req. 2): $64  ´ 6,400 409,600 
Increase in net income before taxes for InterGlobal Industries $312,500

As the answers to requirements (2) and (3) show, $50 is not a goal-congruent transfer price.
Although a transfer is in the best interests of InterGlobal Industries as a whole, a transfer of
$50 will not be perceived by the Compressor Division’s management as in that division’s
best interests.