SOLUTION: 13-52

1. Yes, Air Comfort Division should institute the 5% price reduction on its air
conditioner units because net income would increase by $264,000. 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 $800 $12,000 $760 $13,224.0 $1,224.0
Variable costs:
Compressor $140 $ 2,100 $140 $ 2,436.0 $ 336.0
Other direct material 74 1,110 74 1,287.6 177.6
Direct labor 60 900 60 1,044.0 144.0
Variable overhead 90 1,350 90 1,566.0 216.0
Variable selling 36 540 36 626.4 86.4
Total variable costs $400 $ 6,000 $400 $ 6,960.0 $ 960.0
Contribution margin $400 $ 6,000 $360 $ 6,264.0 $ 264.0

Summarized presentation:

Contribution margin of sales increase ($360  2,400) $864,000

Loss in contribution margin on original volume arising from
decrease in selling price ($40  15,000) 600,000
Increase in net income before taxes $264,000

2. No, the Compressor Division should not sell all 17,400 units to the Air Comfort
Division for $100 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 $71,000. Compressor Division
would be willing to accept any orders from Air Comfort above the 64,000 unit level
at $100 per unit because there would be a positive contribution margin of $43 per
unit. Supporting calculations follow.

Outside Air Comfort

Sales Sales
Selling price ............................................................................... $200 $100
Variable costs:
Direct material .......................................................................... 24 $ 21
Direct labor .............................................................................. 16 16
Variable overhead .......................................................... 20 20
 Variable selling expenses ...................................................... 12 —
Total variable costs ................................................................ $ 72 $ 57
Contribution margin .................................................................. $128 $ 43

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 ($43  17,400) .......................... $748,200

Loss in contribution from loss of sales to outsiders ($128  6,400) .... 819,200
Decrease in net income before taxes ...................................................... $ 71,000

3. Yes, it would be in the best interests of Continental Industries for the Compressor
Division to sell the units to the Air Comfort Division at $100 each. The net
advantage to Continental Industries is $625,000 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.

Cost savings by using compressor unit from Compressor Division:

Air Comfort Division’s outside purchase price .................................... $ 140

Compressor Division’s variable cost to produce (see req. 2). ............ 57
Savings per unit ....................................................................................... $ 83
x Number of units................................................................................ x 17,400
Total cost savings .................................................................................... $1,444,200
Compressor Division’s loss in contribution from loss
of sales to outsiders (see req. 2): $128  6,400 ................................. 819,200
Increase in net income before taxes for Continental Industries .......... $ 625,000

4. As the answers to requirements (2) and (3) show, $100 is not a goal-congruent
transfer price. Although a transfer is in the best interests of Continental Industries
as a whole, a transfer of $100 will not be perceived by the Compressor Division’s
management as in that division’s best interests.