Question

Alpha and Beta are divisions within the same company. The managers of both divisions are evaluated based on their own division’s return on investment (ROI). Assume the following information relative to the two divisions:

	Case
	1		2		3			4
Alpha Division:
Capacity in units		56,000		318,000		102,000			208,000
Number of units now being sold to outside customers		56,000		318,000		79,000			208,000
Selling price per unit to outside customers	$	96	$	41	$	64		$	46
Variable costs per unit	$	59	$	20	$	40		$	32
Fixed costs per unit (based on capacity)	$	23	$	10	$	21		$	8
Beta Division:
Number of units needed annually		10,000		68,000		18,000			56,000
Purchase price now being paid to an outside supplier	$	87	$	40	$	64	*		—

*Before any purchase discount.

Managers are free to decide if they will participate in any internal transfers. All transfer prices are negotiated.

Required:

1. Refer to case 1 shown above. Alpha Division can avoid $6 per unit in commissions on any sales to Beta Division.

a. What is the lowest acceptable transfer price from the perspective of the Alpha Division?

b. What is the highest acceptable transfer price from the perspective of the Beta Division?

c. What is the range of acceptable transfer prices (if any) between the two divisions? Will the managers probably agree to a transfer?

2. Refer to case 2 shown above. A study indicates that Alpha Division can avoid $5 per unit in shipping costs on any sales to Beta Division.

a. What is the lowest acceptable transfer price from the perspective of the Alpha Division?

b. What is the highest acceptable transfer price from the perspective of the Beta Division?

c. What is the range of acceptable transfer prices (if any) between the two divisions? Would you expect any disagreement between the two divisional managers over what the exact transfer price should be?

d. Assume Alpha Division offers to sell 68,000 units to Beta Division for $39 per unit and that Beta Division refuses this price. What will be the loss in potential profits for the company as a whole?

3. Refer to case 3 shown above. Assume that Beta Division is now receiving an 6% price discount from the outside supplier.

a. What is the lowest acceptable transfer price from the perspective of the Alpha Division?

b. What is the highest acceptable transfer price from the perspective of the Beta Division?

c. What is the range of acceptable transfer prices (if any) between the two divisions? Will the managers probably agree to a transfer?

d. Assume Beta Division offers to purchase 18,000 units from Alpha Division at $55.16 per unit. If Alpha Division accepts this price, would you expect its ROI to increase, decrease, or remain unchanged?

4. Refer to case 4 shown above. Assume that Beta Division wants Alpha Division to provide it with 56,000 units of a different product from the one Alpha Division is producing now. The new product would require $27 per unit in variable costs and would require that Alpha Division cut back production of its present product by 28,000 units annually. What is the lowest acceptable transfer price from Alpha Division’s perspective?

Answer 1

1. No spare capacity

A.lowest acceptable transfer price = selling price - cost avoided

= 96-6 = $90

B.higest purchase price = purchase price being paid

= $87

C. No range of acceptable transfer price. Managers will not agree for a transfer.

2.No spare capacity

A.minimum price = $41-5 = $36

B.maximum price = $40

C. Range = $36-$40

Yes, since both the managers would like to keep transfer price in their favour

D. Loss on profits

Loss to Alpha Division = (39-36)*68,000 = $204,000

Loss to beta division = (39-38)*68,000 = $68,000

Loss to company = $272,000

3.spare capacity

A.lowest price = variable cost per unit

= $40

B.highest price = 64-6% = $60.16

C.range = $40-$60.16

Yes, managers will agree for the transfer

D.ROI will increase since the offered price is higher than the variable cost per unit

4.No spare capacity

Lowest acceptable transfer price is the cost incurred on new product plus contribution margin lost on existing product

Cost incurred on new product = $27

Loss of contribution margin for one unit of new product = (46-32)/2 = $7

Lowest acceptable transfer price per unit = $34