Riu Corporation has a Parts Division that does work for other Divisions in the company as...

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Accounting

Riu Corporation has a Parts Division that does work for otherDivisions in the company as well as for outside customers. Thecompany's Repair Division has asked the Parts Division to provideit with 2,000 special parts each year. The special parts wouldrequire $17.00 per unit in variable production costs. The RepairDivision has a bid from an outside supplier for the special partsat $28.00 per unit. In order to have time and space to produce thespecial part, the Parts Division would have to cut back productionof another part-the B83 that it presently is producing. The B83sells for $34.00 per unit, and requires $22.00 per unit in variableproduction costs. Packaging and shipping costs of the B83 are $4.00per unit. Packaging and shipping costs for the new special partwould be only $0.50 per unit. The Parts Division is now producingand selling 10,000 units of the B83 each year. Production and salesof the B83 would drop by 10% if the new special part is producedfor the Repair Division.

Required:

a. What is the range of transfer prices within which both theDivisions' profits would increase as a result of agreeing to thetransfer of 2,000 special parts per year from the Parts Division tothe Repair Division?
b. Is it in the best interests of Riu Corporation for this transferto take place? Explain.
c. What is capital budgeting? Why are capital budgetingdecisions often difficult and risky?
d. In using a capital budgeting method that takes the time valueof money into consideration, management must consider a hurdle ratein making its decisions. What is a hurdle rate? What factors doesmanagement have to consider in selecting a hurdle rate?

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a From the perspective of the Parts Division profits would increase as a result of the transfer if and only if Transfer price Variable cost Opportunity cost The opportunity cost is the contribution margin on the lost sales divided by the number of units transferred Opportunity cost 3400 2200 400 1000 2000 400 10 10000 1000 Therefore Transfer price 1700 050 400 215 From the viewpoint of the parts division the transfer price must be less than the cost of buying the units from the outside supplier Therefore Transfer price 2800 Combining the two requirements we get the following range of transfer prices 215 Transfer price 2800 b Yes the transfer should take place From the viewpoint of See Answer

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Transcribed Image Text

Riu Corporation has a Parts Division that does work for otherDivisions in the company as well as for outside customers. Thecompany's Repair Division has asked the Parts Division to provideit with 2,000 special parts each year. The special parts wouldrequire $17.00 per unit in variable production costs. The RepairDivision has a bid from an outside supplier for the special partsat $28.00 per unit. In order to have time and space to produce thespecial part, the Parts Division would have to cut back productionof another part-the B83 that it presently is producing. The B83sells for $34.00 per unit, and requires $22.00 per unit in variableproduction costs. Packaging and shipping costs of the B83 are $4.00per unit. Packaging and shipping costs for the new special partwould be only $0.50 per unit. The Parts Division is now producingand selling 10,000 units of the B83 each year. Production and salesof the B83 would drop by 10% if the new special part is producedfor the Repair Division.Required:a. What is the range of transfer prices within which both theDivisions' profits would increase as a result of agreeing to thetransfer of 2,000 special parts per year from the Parts Division tothe Repair Division?b. Is it in the best interests of Riu Corporation for this transferto take place? Explain.c. What is capital budgeting? Why are capital budgetingdecisions often difficult and risky?d. In using a capital budgeting method that takes the time valueof money into consideration, management must consider a hurdle ratein making its decisions. What is a hurdle rate? What factors doesmanagement have to consider in selecting a hurdle rate?