Question 1 (18 marks)
The Vancouver Leisure Company (VLC) sells extreme outdoor equipment, specialising in
downhill and cross-country bikes, kayaks etc. VLC has a bike frame manufacturing division
(FMD) that manufactures frames for bikes, and an Extreme Bike Sales division (EBS) that
adds all the other components imported from Europe (gears, wheels, seats etc.). The
technology that FMD utilizes is highly sought after but they do not have a monopoly. Both
divisions are fully decentralized and autonomous profit centres.
FMD’s cost of making an F18 bicycle frame is:
Overhead (based on maximum capacity) 145
Variable selling costs
Cost per unit
Variable selling costs include a commission to an independent sales representative of $50,
$30 in packaging costs and $10 in delivery. Any sales to EBS will avoid packaging and
FMD has fixed overhead of $180,000 and is able to manufacture and sell 4,000 frames a year
at a market price of $1,200.
NOTE: Each bike requires one frame.
Required – Part 1
a) EBS has a product called the Hollyburn bike. The Hollyburn is a high-end downhill bike that
utilizes an F18 frame. Assuming that demand for the Hollyburn bicycle is only 600 units this
year and FMD has demand for 2,500 F18 frames from outside purchasers, what is the
minimum transfer price that FMD is willing to accept from EBS? (2 marks)
b) If FMD was able to sell all of its F18 frames to outside purchasers, what would be the
minimum transfer price that they would accept from EBS? (2 marks)
c) Assume that FMD has a demand of 3,500 F18 frames from outside purchasers. EBS has
estimated that it can sell 1,100 Hollyburns this year. What is the minimum transfer price,
per frame, that FMD will accept from EBS for all 1,100 frames. (2 marks)
Required – Part 2
Assume that FMD can sell all of its production of F18 frames to outside purchasers but is
transferring frames to EBS at $1,200. EBS has just received a special order from a customer
to buy 300 bikes at a price of $3,800 per bike. EBS would incur an additional cost of $200 per
bike to paint the bikes in a special chrome paint. The manager of EBS has excess capacity so
s/he would very much like to fill the order. Currently, EBS sells its bikes at $4,500 generating a
contribution margin of $1,000 per bike. The Manager of FMD has asked the Manager of EBS
to let him increase the transfer price by $150 per bike in an effort to help his division out this
a) What will be the change in the operating income of FMD assuming that the Manager of the
EBS division agrees to increase the transfer price by $150? (3 marks)
b) Assume that EBS takes the order at $3,800 per bike and grants a transfer price of $1,350.
What will the effect be on EBS’s operating income? (2 marks)
c) Is the Manager of EBS likely to accept the proposed increase in transfer price? Provide an
explanation. (3 marks)
d) Would this transaction be in the best interest of the company? Show your calculations.
e) The two managers cannot agree on a transfer price and the special offer may be lost. As
the CEO of VLC, would you get involved in the negotiation? Provide TWO reasons to
support your position. The company’s net income last year was $900,000. (2 marks)
Question 2 (12 marks)
Porky Pig Ltd. (“PPL”) manufactures small home appliances. One of the company’s product
lines is toasters, which it produces in three different models: standard, super, and deluxe.
Each model, in turn, has two versions. (Thus, PPL manufactures six different toasters).
The company currently produces all of the toasters’ components. However, PPL has just
received a proposal from a vendor (supplier) to supply PPL with the heating elements for the
toasters. The design and quality of the heating element is what distinguishes a higher quality
toaster from a lower quality toaster. (PPL currently makes six different elements for the six
different toasters.) The vendor has offered to supply all six different elements at a cost of
$2.60 per element.
PPL produces the elements in its factory in Raincouver, BC, along with all its other toaster
components. For the coming year, PPL has projected an annual production volume of
100,000 elements, with the costs as follows:
Amortization on equipment1
Total production costs
The equipment used to produce the elements has no alternative use and no
The space occupied by the element production activities can be rented out for
$1,000 a month.
This is the salary of the production supervisor who oversees the element
production. This individual would no longer be required if element production
Determine the level of (annual) production at which PPL would be indifferent between
making or buying the elements, assuming excess capacity exists. Based on your
calculation, should they make or buy the heating elements? (6 marks)
Identify THREE other factors that the company should take into account in deciding
whether to make or buy the elements. (3 marks)
The company has an opportunity to sell an additional 10,000 elements to a foreign
distributor. PPL has the (excess) capacity to produce the additional quantity.
(i) What is the minimum price that PPL should charge for the order? (1 mark)
(ii) Assume that PPL is currently experiencing a $25,000 loss from operations (and is
making its own heating elements). What price should PPL charge if it wishes to
make an overall profit of $5,000 from operations? (2 marks)