Question

Orange Inc. is a division of Fruits Inc. Orange Inc produces juice and sells it to a number of companies, as well as to Fruits Inc. who uses it for their division. Recently, the VP of marketing for Fruits Inc approached Orange Inc with a request to make 20 000 units of special juice. The following info is available regarding the Orange Inc.

Selling price of regular juice per unit -> 80$
Variable cost of regular juice per unit -> 45$
Additional variable cost of special juice per unit -> 25$

The fruits inc can purchase the special juice from an outside source for $75 per unit, plus shipping. The shipping equals $2 per unit.

A) calculate the transfer price for each following situations

1. Orange inc has available capacity
2. Has no available capacity and would have to forego sales of 20k units to existing customers to meet this request
3. no available capacity and would have to forego sales of 30k units to exisitng customers to meet this rqeuest.

Answer 1

A) 1) If Orange inc has available capacity then the transfer price for special juice which orange inc. charge should be equal to the total variable cost for manufacturing of special juice. In this case, the orange inc. has available capacity. Hence transfer price will be:-

Transfer price =  Variable cost of regular juice per unit+Additional variable cost of special juice per unit

= $45 per unit + $25 per unit = $70 per unit

Thus the transfer price will be $70 per unit.

2) If orange inc. has no available capacity and for transfering it has to forego some of the sales, then transfer price will be equal to total variable cost and contribution foregone per unit of transfer units. The transfer price for this case is calculated as follows:-

Total variable cost = $70 per unit

Sale price = $80 per unit

Contribution per unit = Sale price - Variable cost = $80 - $70 = $10 per unit

Total Contribution foregone = Sales unit foregone*contribution per unit

= 20,000 units*$10 = $200,000

Contribution foregone per unit = Contibution foregone/units requested

= $200,000/20,000 = $10 per unit

Transfer price = Total Variable cost per unit+Contribution foregone per unit

= $70 per unit+$10 per unit = $80 per unit

Thus the transfer price will be $80 per unit.

3) In this case also, transfer price will be equal to total variable cost and contribution foregone per unit of transfer units. The transfer price for this case is calculated as follows:-

Total variable cost = $70 per unit

Sale price = $80 per unit

Contribution per unit = Sale price - Variable cost = $80 - $70 = $10 per unit

Total Contribution foregone = Sales unit foregone*contribution per unit

= 30,000 units*$10 = $300,000

Contribution foregone per unit = Contibution foregone/units requested

= $300,000/20,000 = $15 per unit

Transfer price = Total Variable cost per unit+Contribution foregone per unit

= $70 per unit+$15 per unit = $85 per unit

Thus the transfer price will be $85 per unit.