Hrubec Products, Inc., operates a Pulp Division that manufactures wood pulp for use in the production of various paper goods. Revenue and costs associated with a ton of pulp follow: Selling price $ 23 Expenses: Variable $ 13 Fixed (based on a capacity of 97,000 tons per year) 6 19 Net operating income $ 4 Hrubec Products has just acquired a small company that manufactures paper cartons. Hrubec plans to treat its newly acquired Carton Division as a profit center. The manager of the Carton Division is currently purchasing 29,000 tons of pulp per year from a supplier at a cost of $20.70 per ton. Hrubec’s president is anxious for the Carton Division to begin purchasing its pulp from the Pulp Division if the managers of the two divisions can negotiate an acceptable transfer price. Required: For (1) and (2) below, assume the Pulp Division can sell all of its pulp to outside customers for $23 per ton. 1. What is the Pulp Division's lowest acceptable transfer price? What is the Carton Division's highest acceptable transfer price? What is the range of acceptable transfer prices (if any) between the two divisions? Are the managers of the Carton and Pulp Divisions likely to voluntarily agree to a transfer price for 29,000 tons of pulp next year? 2. If the Pulp Division meets the price that the Carton Division is currently paying to its supplier and sells 29,000 tons of pulp to the Carton Division each year, what will be the effect on the profits of the Pulp Division, the Carton Division, and the company as a whole? For (3)–(6) below, assume that the Pulp Division is currently selling only 56,000 tons of pulp each year to outside customers at the stated $23 price. 3. What is the Pulp Division's lowest acceptable transfer price? What is the Carton Division's highest acceptable transfer price? What is the range of acceptable transfer prices (if any) between the two divisions? Are the managers of the Carton and Pulp Divisions likely to voluntarily agree to a transfer price for 29,000 tons of pulp next year?
Cost-Volume-Profit Analysis
Cost Volume Profit (CVP) analysis is a cost accounting method that analyses the effect of fluctuating cost and volume on the operating profit. Also known as break-even analysis, CVP determines the break-even point for varying volumes of sales and cost structures. This information helps the managers make economic decisions on a short-term basis. CVP analysis is based on many assumptions. Sales price, variable costs, and fixed costs per unit are assumed to be constant. The analysis also assumes that all units produced are sold and costs get impacted due to changes in activities. All costs incurred by the company like administrative, manufacturing, and selling costs are identified as either fixed or variable.
Marginal Costing
Marginal cost is defined as the change in the total cost which takes place when one additional unit of a product is manufactured. The marginal cost is influenced only by the variations which generally occur in the variable costs because the fixed costs remain the same irrespective of the output produced. The concept of marginal cost is used for product pricing when the customers want the lowest possible price for a certain number of orders. There is no accounting entry for marginal cost and it is only used by the management for taking effective decisions.
Hrubec Products, Inc., operates a Pulp Division that manufactures wood pulp for use in the production of various paper goods. Revenue and costs associated with a ton of pulp follow:
| Selling price | $ | 23 | ||
| Expenses: | ||||
| Variable | $ | 13 | ||
| Fixed (based on a capacity of 97,000 tons per year) |
6 | 19 | ||
| Net operating income | $ | 4 | ||
Hrubec Products has just acquired a small company that manufactures paper cartons. Hrubec plans to treat its newly acquired Carton Division as a profit center. The manager of the Carton Division is currently purchasing 29,000 tons of pulp per year from a supplier at a cost of $20.70 per ton. Hrubec’s president is anxious for the Carton Division to begin purchasing its pulp from the Pulp Division if the managers of the two divisions can negotiate an acceptable transfer price.
Required:
For (1) and (2) below, assume the Pulp Division can sell all of its pulp to outside customers for $23 per ton.
1. What is the Pulp Division's lowest acceptable transfer price? What is the Carton Division's highest acceptable transfer price? What is the range of acceptable transfer prices (if any) between the two divisions? Are the managers of the Carton and Pulp Divisions likely to voluntarily agree to a transfer price for 29,000 tons of pulp next year?
2. If the Pulp Division meets the price that the Carton Division is currently paying to its supplier and sells 29,000 tons of pulp to the Carton Division each year, what will be the effect on the profits of the Pulp Division, the Carton Division, and the company as a whole?
For (3)–(6) below, assume that the Pulp Division is currently selling only 56,000 tons of pulp each year to outside customers at the stated $23 price.
3. What is the Pulp Division's lowest acceptable transfer price? What is the Carton Division's highest acceptable transfer price? What is the range of acceptable transfer prices (if any) between the two divisions? Are the managers of the Carton and Pulp Divisions likely to voluntarily agree to a transfer price for 29,000 tons of pulp next year?
4-a. Suppose the Carton Division’s outside supplier drops its price to only $18 per ton. Should the Pulp Division meet this price?
4-b. If the Pulp Division does not meet the $18 price, what will be the effect on the profits of the company as a whole?
5. Refer to (4) above. If the Pulp Division refuses to meet the $18 price, should the Carton Division be required to purchase from the Pulp Division at a higher price for the good of the company as a whole?
6. Refer to (4) above. Assume that due to inflexible management policies, the Carton Division is required to purchase 29,000 tons of pulp each year from the Pulp Division at $23 per ton. What will be the effect on the profits of the company as a whole?
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