Question

In each of the cases below, assume Division X has a product that can be sold either to outside customers or to Division Y of the same company for use in its production process. The managers of the divisions are evaluated based on their divisional profits.
Case
A B
Division X:
Capacity in units 101,000 105,000
Number of units being sold to outside customers 101,000 81,000
Selling price per unit to outside customers $52 $31
Variable costs per unit $28 $11
Fixed costs per unit (based on capacity) $8 $4
Division Y:
Number of units needed for production 24,000 24,000
Purchase price per unit now being paid to an outside supplier $47 $22

Refer to the data in case B above. In this case, there will be no savings in variable selling costs on intracompany sales.

a. What is the lowest acceptable transfer price from the perspective of the selling division?
b. What is the highest acceptable transfer price from the perspective of the buying division?
c. What is the range of acceptable transfer prices (if any) between the two divisions? If the managers are free to negotiate and make decisions on their own, will a transfer probably take place?

Answer 1

Answer:

a.  $11

b.  $22

c.  Range is $11  to $22

Explanation:

Part a

The lowest acceptable (minimum) transfer price is the price that is acceptable to the transferring division and out of a range of prices, it could be that which would be the best for the company.

Minimum Transfer Price = Variable Costs per unit - Internal Savings + Opportunity Cost

where,

Variable Costs per unit = $11

Internal Savings = $0

Opportunity Cost = $0

therefore,

Minimum Transfer Price = $11

Part b

The highest acceptable(maximum) transfer price is the maximum price that causes the receiving or buying division to breakeven. It could also be the price at which they could purchase the product in the market at arms length position.

therefore,

Maximum Transfer Price = $22

Part c

The best  range of acceptable transfer prices must encourage goal congruence, must facilitate measurement of performance and divisions should function autonomously.

therefore,

The best range of acceptable transfer prices is within the Minimum and Maximum Transfer Price.