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		50,000		284,000		103,000			192,000
Number of units now being sold to outside customers		50,000		284,000		80,000			192,000
Selling price per unit to outside customers	$	98	$	39	$	62		$	45
Variable costs per unit	$	62	$	19	$	38		$	31
Fixed costs per unit (based on capacity)	$	24	$	8	$	20		$	6
Beta Division:
Number of units needed annually		10,000		69,000		19,000			62,000
Purchase price now being paid to an outside supplier	$	89	$	38	$	62	*		—

*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 $4 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 69,000 units to Beta Division for $37 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 5% 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 19,000 units from Alpha Division at $53.90 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 62,000 units of a different product from the one Alpha Division is producing now. The new product would require $28 per unit in variable costs and would require that Alpha Division cut back production of its present product by 31,000 units annually. What is the lowest acceptable transfer price from Alpha Division’s perspective?

Answer 1

ans 1
For case 1
Minimum transfer price is
Selling price-Avoidable cost
98-6	$92
As all units which are produced are sold to outsiders hence
there is no idle capacity Alpha will tranfer in minimum $92
ans 1b
Highest acceptable price is what Beta pays to outsider i.e $89
ans 1c
No, they wont agree to the transaction as Alpha wont give is less than $92
and Beta will be willing to pay $89
ans 2
Minimum transfer price is
Selling price-Avoidable cost
39-3	$36
As all units which are produced are sold to outsiders hence
there is no idle capacity Alpha will tranfer in minimum $36
ans 2b
Highest acceptable price is what Beta pays to outsider i.e $38
ans 2c Range is
between 36 and 38
Yes the transfer can take place
ans 3
a) Now as units sold is less than units produced hence there is idle capacity so there is no
loss of contribution margin it can give minimum at variable cost $38
b) Highest acceptable transfer price is
65*95%	61.75
c) Price range between 38 and 61.75
Yes, they would agree
d) ROI will increase as there be extra contribution margin of
19000*(53.9-38)	302100
ans 4
Lowest acceptable transfer price is
28+(45-31)*31000/62000	35
If any doubt please comment