Question 1. Charleston Inc. categorizes its operations into two divisions: Bermuda and Midiron.

Bermuda Division Midiron Division

Sales revenue $800,000 $600,000
Average invested assets $2,500,000 $3,750,000
Net operating income $160.000 $150,000
Profit margin 20% 25%
Investment turnover 0.32 0.16
Return on investment 6.4% 4%
Residual income $40,000 $(30,000)

Required:
1. Without making any calculations, determine whether each division’s return on
investment is above or below the hurdle rate. How can you tell?
2. What is Charleston’s hurdle rate?
Question 2. The Mitchell Corporation has several divisions, including the Switch Division and
the Appliance Division, each operated as decentralized investment centers. The standard cost and
price information for switches is as below.
Standard cost/switch
Direct materials $4.25
Direct labor 3.75
Variable overhead 2.50
Fixed overhead 4.50
External selling price/switch $20.00
The Appliance Division plans to market a new product in 2024, requiring 20,000 switches, which
could be supplied by the Switch Division. The manager of the Switch Division is willing to sell
the switches to the Appliance Division at its production cost of $15.00 per switch and forego any
mark-up for profit. The manager of the Appliance Division has found, however, that the switches
could be purchased from another outside supplier at a special discounted price of $14.00 /switch,
and is unwilling to buy them internally for more.
a. Will the company as a whole be better off or worse off if the switches are purchased
internally by the Appliance Division? By how much?
b. As the controller of the Switch Division, what minimum transfer price would you
recommend that the manager of the Switch Division accept?
c. Assume that the transfer to the Appliance Division does not occur. The Electronic Division,
another division of the Mitchell Corporation, has requested that the Switch Division supply
it with switches on a one-time-only basis. The Electronic Division requires 30,000
switches, but these switches would have slightly different production requirements. Direct
materials are estimated to increase to $5.50/switch; further, a special machine costing
$72,000 would need to be added to the production process. This machine has no other use
of salvage value. The Electronic Division could purchase these types of switches externally
for $15.50 each. The Switch Division has ample capacity for internal transfer. What’s the
minimum transfer price that the manager of the Switch Division should accept for the
30,000 unit order?
Question 3. Johnson Electric Motors is a multi-divisional decentralized company that produces
various kinds of motors and engines. The top management team at Johnson makes all decisions
regarding purchases of capital assets, while the divisional managers make decisions on sales,
marketing, hiring, production, and logistics in their divisions. The Starter Division of Johnson
Electric Motors manufactures a starter motor with the following standard costs (per unit):

Direct material $5
Direct labor 30
Overhead 15
The direct labor standard is $10 per hour. The overhead rate is 40% variable and 60% fixed per
direct labor hour.

The Starter Division has a capacity of 19,000 direct labor hours and is operating at 16,000 direct
labor hours for the year. Currently, the starter motors sell for $75 in the market.

The Motor Division currently purchases 1,000 starter motors from the Starter Division at the
market price. The company policy is that if mutually agreed upon, the divisional managers are
permitted to negotiate a transfer price. The divisional manager of the Motor Division indicates
that she can purchase the starters from a foreign supplier for $65. Thus, she would like to
negotiate a new transfer price with the Starter Division.
a. What type of responsibility center should the Starter Division be classified as?

b. From the perspective of Johson Electric Motors, ignoring qualitative factors, should the
Moto Division continue to purchase the starters internally or externally?

c. From the perspective of the Starter Division, should it match the foreign supplier’s price?

d. What’s the minimum transfer price per unit that the Starter Division should charge if the
Motor Division wants to purchase 2,000 additional starter motors from the Starter
Division? Assume the new order is all-or-none, i.e., the Motor Division will not accept to
buy any less than 2,000 starters.
Direct labor hours required by each unit=
Direct labor hours required by 2,000 starters=
Remaining capacity=
Lost external sales (in units) due to internal transfer =
Min P=
Question 4: Barker makes electric forklift trucks. It has two divisions: Batteries and Vehicles.

• The Battery Division makes a standard 12V battery

• The Vehicle Division wants to buy #50,000 batteries per year.
• It is presently buying these batteries from an outside supplier for $39 per battery.
• The Battery Division has a production capacity of #300,000 batteries.
• It can sell batteries on the outside market for $40 per battery.
• Variable costs per battery are $18 and fixed costs per battery (based on capacity) are $7.

(1) Suppose the Battery Division has enough idle capacity to supply the Vehicle Division
without diverting batteries from the outside market? What is the lowest acceptable transfer
price from the viewpoint of the selling division?

(2) Suppose the Battery Division is already operating at capacity selling to the outside market.
What is the lowest acceptable transfer price from the viewpoint of the selling division?
(3) Suppose the Battery Division is still operating at capacity, however, it can avoid $4 of
variable costs (e.g. selling commissions) for internal sales. Now, what is the lowest
acceptable transfer price from the viewpoint of the selling division?

(4) Suppose the Vehicle Division wants the Battery Division to supply it with 20,000 special
heavy-duty batteries.
• The variable cost for each heavy-duty battery would be $27.
• The Battery Division has no idle capacity.
• Also, heavy-duty batteries require more processing time, and will displace 22,000 regular
batteries from production.
What is the minimum transfer price for the Battery Division for heavy-duty batteries?