Question

Conglomerate Co. has two divisions. Division A manufactures widgets while Division B manufactures woblets. In the production of widgets, one of the key components is a woblet and, hence, Division A could source its woblets temporarily directly from Division B rather than going to the external market. The following data pertains to woblets: Sales price $60.00 per woblet Direct materials 22.00 Direct labor 10.00 Variable overhead 6.00 Allocated fixed costs 12.00 Division A has asked Division B to supply 4,000 woblets. Currently, Division B has the capacity to make 10,000 woblets annually. If Division B is currently producing and selling 8,000 woblets, what is the minimum transfer price per custom woblet that would permit Division B to maintain profit at current levels? In this scenario, Division A wants to buy all 4,000 woblets from Division B or none at all.

Answer 1

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Conglomerate Co.

We will calculate profit at both levels i.e. at 10,000 units and 6,000 units. The difference in the profit should be recovered from Dept. A along with the variable costs to have the sesame level of profit.

	10,000 units	6,000 units
Sell price	60.00	60.00
Direct materials	22.00	22.00
Direct Labor	10.00	10.00
Variable overhead	6.00	6.00
Total variable cost	38.00	38.00
Contribution per unit	22.00	22.00
Number of units	10,000.00	6,000.00
Total Contribution	220,000.00	132,000.00
Allocated fixed costs	120,000.00	120,000.00
(10,000*12)
Profit	100,000.00	12,000.00
Profit to be recovered		88,000.00
Minimum transfer price calculation
Profit to be recovered		88,000.00
Number of units		4,000.00
Per unit		22.00
Add: total variable costs per unit		38.00
Minimum transfer price		60.00
So minimum transfer price is same as sell price i.e. $ 60.