The Rubber Division of Morgan Company manufactures rubber moldings and sells them externally for $50. Its variable cost is $20 p
er unit, and its fixed cost per unit is $7. Morgan's president wants the Rubber Division to transfer 5,000 units to another company division at a price of $27. Assuming the Rubber Division has available capacity of 5,000 units, the minimum transfer price it should accept is
This is because the minimum acceptable price is the break even price for the division. We will not include $7 fixed cost because it is not relevant to this transaction as it has to be paid regardless of this transfer.
The Minimum price thus is the price that cancels out all relevant costs namely the variable costs of $20.
Relevant costs are also known as the incremental costs that are incurred only when a particular activity is undertaken. Fixed costs as such are not incremental. Since there is spare capacity we are not forgoing any profits from external exchanges that needs to be accounted for.
There are a lot of reasons in buying a certain a product and sometimes we buy things which are not really necessary. One great example for emotional consumer motive in when we buy food because we need them to survive in this world.
