Rabbid Industries Ltd consists of three decentralized divisions: Brentwood Division, Crater Division and Dollar Division. The managing director of Rabbid Industries has given the managers of the three divisions the authority to decide whether to sell their products outside the company or between themselves at a transfer price determined by the division managers. The external market for the company’s products is very active and there are many competitors. so sales made internally or externally by the divisions will not affect market prices. Intermediate markets will always be available for Brentwood. Crater and Dollar to purchase their manufacturing needs or sell their product. Each division manager attempts to maxim his at the current level of operating assets for the division.
The manager of Crater Division is currently considering the following two orders:
• Dollar Division needs 3000 units of a motor that can be supplied by Crater Division. To manufacture these motors. Crater would purchase components from Brentwood Division at a transfer price of $900 per unit. Brentwood’s variable cost for these components is $450 per unit. Crater Division would further process these Components at a variable cost of $750 per unit.
• Eros Company wants to order 3500 motors from the Crater Division. This is a custom-built product and the price will be $1875 per unit. Crater would purchase components for these motors from Brentwood’s Division at a transfer price of $750 per unit. Brentwood’s variable cost for these components is $375 per unit. Crater Division will further process these components at a variable cost of $600 per unit.
Crater Division’s plant capacity is limited, and the company can accept either the Eros order or the Dollar order, but not both. The managing director of Pabbid Industries and the manager of Crater Division agree that it would not be beneficial to increase capacity.
If Dollar Division cannot obtain the motors from Crater Division, it will purchase the motors from Frantic Company which has offered to supply the same motors to Dollar Division at a price of $2 250 per unit. Frantic Company would also purchase 3000 components from Brentwood Division at a price of $300 for each of these motors. Brentwood’s variable cost for these components is $300 per unit.
Required:
1. If the manager of Crater Division wants to maximise the division’s short-run determine whether Crater Division should:
(a) Sell motors to Dollar Division at the prevailing market price; or
(b) Accept the Eros Company order.
2. Independent of your answer to requirement 1, assume that Crater Division decides to accept the Eros Company contract. Determine if this decision is in the best interests of Pabbid Industries?
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