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Oxford Company has two divisions. Thames Division, which has an investment base of $80,700,000, produces and sells 940,000 units of a product at a market price of $141 per unit. Its variable costs total $42 per unit. The division also charges each unit $71 of fixed costs based on a capacity of 1,100,000 units.
Lakes Division wants to purchase 210,000 units from Thames. However, it is willing to pay only $82 per unit because it has an opportunity to accept a special order at a reduced price. The order is economically justifiable only if Lakes can acquire Thames’ output at a reduced price.
Division managers are evaluated using residual income using a 12 percent cost of capital
Required:
a. What is the residual income for Thames without the transfer to Lakes?
b. What is Thames’s residual income if it transfers 210,000 units to Lakes at $82 each?
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