4. Central Coffee Co. recently opened a gourmet coffee café in downtown Napervil
ID: 342248 • Letter: 4
Question
4. Central Coffee Co. recently opened a gourmet coffee café in downtown Naperville. Central's top management has organized the business into two divisions-the Roasting/Packaging Division and the Café Division The Roasting/Packaging Division can sell to outside customers or sell the product to the Café Division-who will grind, brew, and sell the coffee. Monthly data are as follows: Monthly production capacity Average selling price to outside customers Variable cost per pound 25,000 pounds $10.50 per pound Direct materials (coffee) Direct materials (packaging) Direct labor Variable overhead $ 2.95 $ 0.35 1.00 $ 0.20 $ 3.00 Fixed cost per pound The Café Division requires 3,000 pounds per month and is currently paying an outside supplier $9.75 per pound. Consider each part below independently Required: a. Determine the Roasting/Packaging Division's normal contribution margin per unit and contribution margin ratio for sales made to outside customers. b. If outside customers demand only 20,000 units per year, what is the range of acceptable transfer prices for the Roasting/Packaging Division selling 3,000 pounds to the Cafe Division?Explanation / Answer
a) Total Variable costs per unit of Roasting division = Material(coffee)+Materials(packaging)+Labor+Variable OH
= $2.95+$0.35+$1.00+$0.20 = $4.50
Contribution margin = Selling price per unit - Variable costs per unit
= $10.50 - $4.50 = $6.00
Contribution margin ratio = Contribution margin/Selling price
= $6.00/$10.50 = 0.5714 or 57.14%
b) The cafe division is currently buying 3,000 pounds of required material from outside supplier at $9.75 per pound. Therefore cafe division can pay to the Roasting division upto $9.75 per pound (maximum). Above this price Cafe division will not buy from Rosting division. Hence the maximum transer price in this case will be $9.75 per pound.
As the total monthly production capacity of Roasting division is 25,000 pounds and currently outside customers demand is only 20,000 pounds, therefore there is an excess capacity of 5,000 pounds (25,000 - 20,000) in the Roasting division. As the requirement of Cafe division is 3,000 pounds, the Roasting division can transferred the required materials to cafe division without losing sales to outside customers. The agreed transfer price for roasting division will be equal to total variable cost per pound (i.e. $4.50 per pound). Below this price of $4.50 Roasting division will not agree.
Hence the acceptable range of transfer prices in this case will be from $4.50 to $9.75 per pound.
c) As discussed in the part b, the maximum transfer price agreed to Cafe division is $9.75 per pound.
As there is no excess capacity in roasting division because all 25,000 pounds are demanded by outside customers therefore the transfer price in this case will include the contribution margin per unit to be lost if material sold to Cafe division (i.e. $6.00 per unit)
Minimum Transfer price acceptable to Roasting division = Variable cost+Contribution lost-Saving in variable cost
= $4.50+$6.00-$0.30 = $10.20
Therefore minimum acceptable transfer price is $10.20 whereas maximum acceptable transfer price to Cafe division is $9.75. Thus there is no acceptable range of transfer prices, therefore it is not likely that a transfer will occur.
d) The maximum price acceptable to Cafe division is $9.75 per pound as discussed in parts b and c.
There is an excess capacity of 2,000 pounds in this case (25,000 - 23,000) but the requirement of Cafe division is 3,000 pounds, thus Roasting division has to sacrifice the contribution margin on 1,000 pounds. Therefore the contribution margin lost will be included in minimum acceptable transfer price.
Minimum acceptable transfer price to Roasting division = Variable cost+Contribution lost-Saving in cost
Total contribution lost = 1,000 pounds*$6.00 = $6,000
Contribution lost per pound = $6,000/3,000 pounds = $2.00 per pound
Minimum acceptable transfer price to Roasting division = $4.50+$2.00-$0.40 = $6.10
Minimum acceptable transfer price is $6.10 and maximum acceptable transfer price to Cafe division is $9.75. Thus there is an acceptable range of transfer prices from $6.10 to $9.75, therefore it is most likely that a transfer will occur.
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