Word Wizard is a publishing company with a number of different book lines. Each

Question

Word Wizard is a publishing company with a number of different book lines. Each line has contracts with a number of different authors. The company also owns a printing operation called Quick Press. The book lines and the printing operation each operate as a separate profit center. The printing operation earns revenue by printing books by authors under contract with the book lines owned by Word Wizard, as well as authors under contract with other companies. The printing operation bills out at $0.01 per page, and a typical book requires 500 pages of print. A manager from Business Books, one of the Word Wizards book lines, has approached the manager of the printing operation offering to pay $0.007 per page for 1,500 copies of a 500-page book. The book line pays outside printers $0.009 per page. The printing operation's variable cost per page is $0.004.

Determine whether the printing should be done internally or externally, and the appropriate transfer price, under each of the following situations.

A) The top management of Word Wizard believes that the printing operation should alays do the printing for the company's authors. On a number of occasions, it has forced the printing operation to cancel jobs with outside customers in order to meet the needs of its own lines. Discuss the pros and cons of this approach.

B) Calculate the change in contribution margin to each division, and to the company as a whole, if top management forces the printing operation to accept the $0.007 per page transfer price when it has no available capacity

Explanation / Answer

A)    Printing operation division has capacity shortage (working at full capacity) and therefore it cannot accept external orders. If it accepts the external orders it cannot fully print the own author books. Printing division earns $0.01 per page of a typical 500-page book. Therefore, the selling price is $5 per book ($0.01 × 500 pages). As printing operation division is working at full capacity (not being print external author’s books) the transfer price to book line division would be the price at which it can sell a book is $5.

Pros of this approach:

When printing division sells its books outside or to book line division at $5 per book, it is not compromising with the selling price and the profit on the book.

Cons of the approach:

While printing operation division unable to transfer the book to book line division at $3.5 ($0.007 × 500 pages), book line has to buy it from external market at $4.5 per book. Therefore, loss to the company as a whole is $1 ($4.5 - $3.5) per book printing.

B) At the transfer price of $3.5 ($0.007 * 500 pages) for 1500 books to book line division, printing division losses its contribution of $750 (1500 books *$5 = $7,500)-(1500 books * $4.5 = $6,750).

For book line division it is beneficial to get the book from printing division at $3.5 per book and its contribution increases to $1,500 (1,500 books * $4.5) – (1,500 books * $3.5).

For company as a whole, contribution would be $750 ($1500-$750).

When company sells at $5 per book at market:

Note: it is assumed that printing division has market of 1,500 books.

Particulars Printing
division Book line
divison Company as
a whole Revenue (1500 books * $5) $ 7,500 $ -   $ 7,500 Less: Variable cost (1500 books * $2) $ 3,000 $ -   $ 3,000 Profit $ 4,500 $ -   $ 4,500

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