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:

Alpha Division:	1	2	3	4
Capacity in units	52000	304000	104000	207000
# of units now being sold to outside customers	52000	304000	78000	207000
Selling price per unit to outside customers	101	38	61	47
Variable costs per unit	64	17	38	31
Fixed costs per unit (based on capacity)	26	5	19	7
Beta Division:
# of units needed annually	10700	72000	20000	64000
Purchase price now being paid to an outside supplier	93	35	61*	-

*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 $4 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?

?

less than or equal to

Transfer price

less than or equal to

?

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 72,000 units to Beta Division for $34 per unit and that Beta Division refuses this price. What will be the loss in potential profits for the company as a whole?

?

less than or equal to

Transfer price

less than or equal to

?

3. Refer to case 3 shown above. Assume that Beta Division is now receiving an 4% 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 20,000 units from Alpha Division at $53.56 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 64,000 units of a different product from the one Alpha Division is producing now. The new product would require $26 per unit in variable costs and would require that Alpha Division cut back production of its present product by 32,000 units annually. What is the lowest acceptable transfer price from Alpha Division’s perspective?

Answer 1

1a. The Lowest acceptable transfer price from the perspective of the Alpha Division

Lowest Possible Transfer Price > or Equal to (Variable Cost - Savings) + (Contribution Lost)

Lowest Possible Transfer Price > or Equal to (64 - 4) + (101 - 64)

Lowest Possible Transfer Price >= 97

1b. Highest acceptable transfer price from the perspective of the Beta Division = $93

1c. Range of Transfers is For Alpha >=$97 and For Beta <=$93

1d. Managers will not agree for transfer as they are not getting into the range of transfer price

2a. The Lowest acceptable transfer price from the perspective of the Alpha Division

Lowest Possible Transfer Price > or Equal to (Variable Cost - Savings) + (Contribution Lost)

Lowest Possible Transfer Price > or Equal to (17 - 5) + (38 - 17)

Lowest Possible Transfer Price >= $33

2b. Highest acceptable transfer price from the perspective of the Beta Division = $35

2c. Range of Transfers is For Alpha >=$33 and For Beta <=$35 or $33<=Transfer Price<= $35

2d. The Mangers will agree for transfer as their price is in range

Potential Loss to company as a whole = (Outside Price - Internal Transfer Price) * Units

Potential Loss to company as a whole = (35 - 34) * 72000 = $72000

3a. The Lowest acceptable transfer price from the perspective of the Alpha Division

Lowest Possible Transfer Price > or Equal to (Variable Cost - Savings) + (Contribution Lost)

Lowest Possible Transfer Price > or Equal to (38) + (0)

Lowest Possible Transfer Price >= $38

3b. Highest acceptable transfer price from the perspective of the Beta Division = $61 * (1 - 4%) = $58.56

3c. Range of Transfers is For Alpha >=$38 and For Beta <=$58.56 or $38<=Transfer Price<= $58.56

3d. ROI will Increase

ROI = (Selling price - Variable Cost) * Units = (53.56 - 38) * 20000 = $311200

4

The Lowest acceptable transfer price from the perspective of the Alpha Division

Lowest Possible Transfer Price > or Equal to (Variable Cost - Savings) + (Contribution Lost)

Lowest Possible Transfer Price > or Equal to (26 - 0) + (16 * 32000 / 64000)

Lowest Possible Transfer Price >= $34