Production of sofas at the Cosyhome factory depends on two highly autonomous divisions within the firm. The Woodie division is responsible for manufacturing the wooden chair frame and the Softie division produces the fabric to cover the chairs. Cosyhome operates in a very seasonal and highly competitive market and therefore is keen to implement improvements to its products. One such improvement is a revolutionary new nylon fabric. The Softie division has been asked by the Woodie division to produce the fabric for 4,000 chairs. If Softie meets this request, it will have to reduce output of its existing fabric which it currently sells to firms outside Cosyhome at £15 per metre. This is also the price Woodie must pay for any material purchased from Softie. No external market is expected to be available for the highly specialised nylon fabric. Woodie anticipates that chairs made with the new material will be sold for £23.90 more than at present. Market resistance to higher prices will prevent Woodie from covering all its chairs in the more expensive nylon fabric Sales of sofas covered in the new material will allow Woodie to use some of its current excess capacity (20% of practical output). Woodie would require 12,000 metres of the new material a year from Softie. Current operating data for Softie's existing product and the new material are given below. Table 1: Current operating data New Material (per metre) Existing Material (per metre) Direct Materials £11.00 £7.00 Direct Labour £3.00 £2.50 Variable Overhead £2.00 £2.00 Fixed Overhead* £0.50 £0.50 £16.50 £12.00 * Fixed overhead costs are not expected to rise with production of the new material. (a) Determine the transfer price for the new material. (b) Determine the maximum and minimum transfer prices which might be considered. (c) If production of the new material does not interfere with production of existing materials i.e. Softie has excess capacity, would there be any change in the transfer price established in (a)?
Production of sofas at the Cosyhome factory depends on two highly autonomous divisions within the firm. The Woodie division is responsible for manufacturing the wooden chair frame and the Softie division produces the fabric to cover the chairs. Cosyhome operates in a very seasonal and highly competitive market and therefore is keen to implement improvements to its products. One such improvement is a revolutionary new nylon fabric.
The Softie division has been asked by the Woodie division to produce the fabric for 4,000 chairs. If Softie meets this request, it will have to reduce output of its existing fabric which it currently sells to firms outside Cosyhome at £15 per metre. This is also the price Woodie must pay for any material purchased from Softie. No external market is expected to be available for the highly specialised nylon fabric. Woodie anticipates that chairs made with the new material will be sold for £23.90 more than at present. Market resistance to higher prices will prevent Woodie from covering all its chairs in the more expensive nylon fabric
Sales of sofas covered in the new material will allow Woodie to use some of its current excess capacity (20% of practical output). Woodie would require 12,000 metres of the new material a year from Softie.
Current operating data for Softie's existing product and the new material are given below.
Table 1: Current operating data
|
|
New Material (per metre) |
Existing Material (per metre) |
|
Direct Materials |
£11.00 |
£7.00 |
|
Direct Labour |
£3.00 |
£2.50 |
|
Variable |
£2.00 |
£2.00 |
|
Fixed Overhead* |
£0.50 |
£0.50 |
|
|
£16.50 |
£12.00 |
* Fixed overhead costs are not expected to rise with production of the new material.
(a) Determine the transfer price for the new material.
(b) Determine the maximum and minimum transfer prices which might be considered.
(c) If production of the new material does not interfere with production of existing materials i.e. Softie has excess capacity, would there be any change in the transfer price established in (a)?
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