Question

Clear's Custom Window division has been purchasing a certain window components from Duwee, Cheatim & How Company. However it was determined that it can use one of the frames from the Framing division. The Framing Division, which is operating at capacity, incurs an incremental manufacturing cost of $65 per frame. The Picture Framing Division can sell all its output to the outside market at a price of $100 per frame, after incurring a variable marketing and distribution cost of $8 per frame. If the Window division purchases frames from Duwee at a price of $100 per frame, it will incur a variable purchasing cost of $7 per frame. Clear View's division managers can act autonomously to maximize their own division's operating income.

1. What is the minimum transfer price at which the Frame manager would be willing to sell frames to the Window Division?

2.What is the maximum transfer price at which the Window manager would be willing to purchase frames from the Framing Division?

3. Now suppose that the Framing Division can sell only 70% of its output capacity of 20,000 frames per month on the open market. Capacity cannot be reduced in the short run. The Windows Division can assemble and sell more than 20,000 windows per month.

a. What is the minimum transfer price at which the Framing manager would be willing to sell frames to the Windows Division?

b. From the point of view of Clear View's management, how much of the Framing Division's output should be transferred to the Window Division?

c. If Clear View mandates the Framing and Windows managers to "split the difference" on the minimum and maximum transfer prices they would be willing to negotiate over, what would be the resulting transfer price? Does this price achieve the outcome desired in requirement 3b?

Answer 1

Solution

1.

The minimum transfer price at which the framing manager would be willing to sell is :

=$100(sales price )- $8(distribution cost)

=$92

2.

maximum transfer price at which the Window manager would be willing to purchase frames from the Framing Division:

=$100(purchase price)+$7(purchasing cost)

=$107

3.a

Framing division has excess capacity of 6,000 frames(30%×20000) . The minimum transfer price would be $65 (incremental cost)for 6,000 frames and for remaining 14,000 frames , the minimum transfer price would be $92.

3.b.

From the point of view of Clear View's management,all of the Framing division output should be transferred to them . This will avoid $7 variable purchasing cost and $8 distribution cost.

3.c.

If the Framing division and window division could come to an agreement to "split the difference" the value would have been between $107 and $92. It would be between middle of them $99.50{(107+92)/2}. Clear view can set this price as bench mark price as it is beneficial for both the divisions.