Question

LJM Corporation includes two divisions, Shay Division and Patty Division. The Shay Division makes specialized filters, including one that could be used by the Patty Division. Costs for the filter are variable costs, $16; fixed costs, $20. Shay Division has capacity to make 20,000 of the filters, and it is operating at capacity. It sells the filters to other companies for $52 each. The Patty Division needs 8,000 filters per year, and it has been purchasing them from another company for $45 each. Required: 1) If a transfer were to occur between Shay Division and Patty Division, what is the maximum that Patty Division should be willing to pay for the filters? 2) If a transfer were to occur between Shay Division and Patty Division, what is the minimum price that Shay Division should be willing to accept?

Answer 1

Answer:

LJM Corporation

1. The Maximum price that Patty Division should be willing to pay for the filters is: $45.

2. Minimum price that Shay Division should be willing to accept is: $52.

Explanation:

a) Data and Calculations:

                               Shay Division   Patty Division

Costs:

Variable costs              $16                      

Fixed costs                    20

Sales/purchase price    52                      $45

Capacity/requirement  20,000             8,000

Maximum price that Patty Division should be willing to pay for the filters is: $45.

Minimum price that Shay Division should be willing to accept is: $52.

b) The minimum transfer price should be determined based on the variable costs and the opportunity costs.  The opportunity cost for Shay Division is $36 ($52 - $16).  For Patty Division, the maximum price it should be willing to pay is the opportunity cost, which is the price Patty pays when it buys the filters from the market.