Elise Carpets Inc. has just acquired a new backing division that produces a rubber backing, which itsells for $3.30 per square yard. Sales are about 1,200,000 square yards per year. Since the BackingDivision has a capacity of 2,000,000 square yards per year, top management is thinking that it mightbe wise for the company's Tufting Division to start purchasing from the newly acquired Backing Divi-sion. The Tufting Division now purchases 600,000 square yards per year from an outside supplier at aprice of $3.00 per square yard. The current price is lower than the competitive $3.30 price as a resultof the large quantity discounts. The Backing Division's cost per square yard follows.Direct materials..Direct labor....Variable overhead..Fixed overhead (1,200,000 level)Total cost....$1.800.450.370.15$2.77Requireda. If both divisions are to be treated as investment centers and their performance evaluated by theROI formula, what transfer price would you recommend? Why?b. If fixed costs are assumed not to change, determine the effect on corporate profits of making thebackingc. Based on your transfer price, would you expect the ROI in the Backing Division to increase, de-crease, or remain unchanged? Explaind. What would be the effect on the ROI of the Tufting Division using your transfer price? Explaine. Assume that the Backing Division is now selling 2,000,000 square yards per year to retail outletsWhat transfer price would you recommend? What will be the effect on corporate profits?f. If the Backing Division is at capacity and decides to sell to the Tufting Division for $3.00 persquare yard, what will be the effect on the company's profits?

Question
Asked Nov 27, 2019
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Elise Carpets Inc. has just acquired a new backing division that produces a rubber backing, which it
sells for $3.30 per square yard. Sales are about 1,200,000 square yards per year. Since the Backing
Division has a capacity of 2,000,000 square yards per year, top management is thinking that it might
be wise for the company's Tufting Division to start purchasing from the newly acquired Backing Divi-
sion. The Tufting Division now purchases 600,000 square yards per year from an outside supplier at a
price of $3.00 per square yard. The current price is lower than the competitive $3.30 price as a result
of the large quantity discounts. The Backing Division's cost per square yard follows.
Direct materials..
Direct labor....
Variable overhead..
Fixed overhead (1,200,000 level)
Total cost....
$1.80
0.45
0.37
0.15
$2.77
Required
a. If both divisions are to be treated as investment centers and their performance evaluated by the
ROI formula, what transfer price would you recommend? Why?
b. If fixed costs are assumed not to change, determine the effect on corporate profits of making the
backing
c. Based on your transfer price, would you expect the ROI in the Backing Division to increase, de-
crease, or remain unchanged? Explain
d. What would be the effect on the ROI of the Tufting Division using your transfer price? Explain
e. Assume that the Backing Division is now selling 2,000,000 square yards per year to retail outlets
What transfer price would you recommend? What will be the effect on corporate profits?
f. If the Backing Division is at capacity and decides to sell to the Tufting Division for $3.00 per
square yard, what will be the effect on the company's profits?
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Elise Carpets Inc. has just acquired a new backing division that produces a rubber backing, which it sells for $3.30 per square yard. Sales are about 1,200,000 square yards per year. Since the Backing Division has a capacity of 2,000,000 square yards per year, top management is thinking that it might be wise for the company's Tufting Division to start purchasing from the newly acquired Backing Divi- sion. The Tufting Division now purchases 600,000 square yards per year from an outside supplier at a price of $3.00 per square yard. The current price is lower than the competitive $3.30 price as a result of the large quantity discounts. The Backing Division's cost per square yard follows. Direct materials.. Direct labor.... Variable overhead.. Fixed overhead (1,200,000 level) Total cost.... $1.80 0.45 0.37 0.15 $2.77 Required a. If both divisions are to be treated as investment centers and their performance evaluated by the ROI formula, what transfer price would you recommend? Why? b. If fixed costs are assumed not to change, determine the effect on corporate profits of making the backing c. Based on your transfer price, would you expect the ROI in the Backing Division to increase, de- crease, or remain unchanged? Explain d. What would be the effect on the ROI of the Tufting Division using your transfer price? Explain e. Assume that the Backing Division is now selling 2,000,000 square yards per year to retail outlets What transfer price would you recommend? What will be the effect on corporate profits? f. If the Backing Division is at capacity and decides to sell to the Tufting Division for $3.00 per square yard, what will be the effect on the company's profits?

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Expert Answer

Step 1

Since the student has posted multiple requirements, we will answer only the first three parts.

 

Thank You

Step 2

Requirement a:

 

Compute the manufacturing cost.

 

 

The backing division has a surplus capacity of 800,000 sq. yards per year which is idle capacity and not used by the backing division of the company for sale in the market. Hence, any units till 800,000 units if are transferred to any other division, then it can be transferred at cost of manufacturing such kind of units. The backing division can transfer units at this cost without reducing their contribution from the external market. Since the tufting department is purchasing the product at $3 per unit at present from the external market, they are likely to reject any price above $3 and will accept the lower price of $2.77.

Step 3

Requirement b:

 

Compute the total profits from both sales to external ...

Sale to External Market
Particulars
Sale
Less: Cost of manufacturing
Contribution
Less: Fixed Cost
Profit
Unit Sold
Total Profit
Transfer Pricing
Amount (SParticulars
3.3 Transfer Pricing
2.62 Less: Cost of Sales
0.68 Contribution
0.15 Less: Fixed Cost
0.53 Profit
1.200,000 Unit Sold
636,000 Total Profit
Amount (S)
2.77
2.62
0.15
0
0.15
600,000
90.000
Compute the savings in cost of Tufting division.
Savings in cost of
- Sale to external market-Transfer Price
Tufting Division
-S3-$2.77
-S0.23 per unit
Compute the total savings in cost of Tufting division.
Total Savings in cost of
Units SoldxSavings
Tufting Division
600,000 $0.23
-$138,000
Compute the overall increase in corporate profits.
Overall increase in
=Total profits from transfer pricing + Total Savings in cost
Corporate profits
$90,000+S138,000
$228,000
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Sale to External Market Particulars Sale Less: Cost of manufacturing Contribution Less: Fixed Cost Profit Unit Sold Total Profit Transfer Pricing Amount (SParticulars 3.3 Transfer Pricing 2.62 Less: Cost of Sales 0.68 Contribution 0.15 Less: Fixed Cost 0.53 Profit 1.200,000 Unit Sold 636,000 Total Profit Amount (S) 2.77 2.62 0.15 0 0.15 600,000 90.000 Compute the savings in cost of Tufting division. Savings in cost of - Sale to external market-Transfer Price Tufting Division -S3-$2.77 -S0.23 per unit Compute the total savings in cost of Tufting division. Total Savings in cost of Units SoldxSavings Tufting Division 600,000 $0.23 -$138,000 Compute the overall increase in corporate profits. Overall increase in =Total profits from transfer pricing + Total Savings in cost Corporate profits $90,000+S138,000 $228,000

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