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		54,000		295,000		102,000			198,000
Number of units now being sold to outside customers		54,000		295,000		77,000			198,000
Selling price per unit to outside customers	$	98	$	39	$	65		$	46
Variable costs per unit	$	62	$	17	$	39		$	32
Fixed costs per unit (based on capacity)	$	23	$	7	$	23		$	7
Beta Division:
Number of units needed annually		9,800		65,000		19,000			64,000
Purchase price now being paid to an outside supplier	$	92	$	37	$	65	*		—

*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?

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 65,000 units to Beta Division for $36 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 $56.75 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 $28 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

1. In case 1 we can see that alpha division is able to sell all it's capacity i.e. 54000 units. If instead of selling to outside customer, he will choose to transfer internally then it will loose the whole contribution amount which it is presently getting. This, it would bewilling to transfer internally only on the price which it is currently selling to outside customer in order to avoid any loss of contribution

(a) . Lowest acceptable transfer price from perspective of alpha division is the price it is getting from outside customer less any saving in cost on internally transferring units

Thus, acceptable transfer price to alpha division = $98-$4 = $94 per unit.

(b) . Beta division will not accept any unit at price more than what it is currently paying .

Thus, highest acceptable transfer price from perspective of beta division = $92 per unit.

(c) . From above discussion we can conclude that range of acceptable transfer price will be between $92 to $94.

Transfer price will not be acceptable to managers of both division. Since alpha division wants minimum of $94 whereas beta division can pay maximum of $92, thus they cannot negotiate.

Hence, managers would probably not agree to transfer.

2 . Again in case 2 also , alpha is able to sell all it's capacity and hence, it will require from beta price at which it is selling outside less any cost saved on internal transfer.

(a) . Lowest acceptable transfer price from perspective of alpha division will be $39-$5 = $34. Per unit.

(b) . Highest acceptable transfer price from perspective of division beta will be what it is paying currently for the product i.e. $37.

(c) . Range of transfer between both the division will be $34 to $37. Per unit. Yes there may be disagreement between the managers of both the division. For instance manager of division Alpha may want maximum possible transfer price within the mentioned range i.e. $37 whereas manager of division beta will want lowest possible transfer price within the range give. I.e. $34 per unit.

(d) . If beta division refuses , then loss to company will be the difference between prices at which it is getting currently and the lowest acceptable price for division A i.e.

(37-34)x65000 = $195000.

Thus, if division beta refuses the transfer from division A then loss to the company as a whole will be of $195000.

3 . In case 3 we can clearly see that division A is not able to sell all what it can produce this, it has idle capacity and it can see the balance units at variable cost only . Since fixed cost will continue to occur even if it produces more units or not and also there is not loss of contribution to alpha division to sell units equivalent to its its capacity.

(a) . Lowest acceptable transfer price from perspective of division alpha is its variable cost involved in manufacturing.

Thus, transfer price from perspective of alpha division = $39.

(b) . Highest accpetable transfer price from perspective of beta division is the price at which it is getting from outside supplier, which is

$65-(5% of $65 )= $61.75.

(c) . As per above discussion rate of transfer price will be $39 to $61.75 per unit. Since, there is idle capacity with division Alpha and it's quoted price will come under the current price paid by division .B. Hence, managers will agree to a transfer

(d) . Since, division beta is willing to pay to division A price of $56.75 which is more than it's variable cost and minimum transfer price acceptable to division Alpha, this transfer price of $56.75 will be acceptable to division beta.

Further since it is more than variable cost it will increase the contribution of alpha division, which will ultimately increase the ROI for alpha division.

4. Alpha division currently do not have any idle capacity and any reduction in it's production will decrease its its contribution by the number of units reduced. Thus, contribution lost = (46-32)x32000 = $448000.

Lowest acceptable transfer price to alpha will be variable cost + contribution lost

= $28+$448000/64000

= $28+$7 = $35.

Thus, lowest acceptable transfer price from alpha division perspective in respect of new product = $35 per unit of new product.