Question

Division Y has asked Division X of the same company to supply it with 7,000 units of part L763 this year to use in one of its products. Division Y has received a bid from an outside supplier for the parts at a price of $43 per unit. Division X has the capacity to produce 28,000 units of part L763 per year. Division X expects to sell 25,200 units of part L763 to outside customers this year at a price of $46.00 per unit. To fill the order from Division Y, Division X would have to cut back its sales to outside customers. Division X produces part L763 at a variable cost of $35 per unit. The cost of packing and shipping the parts for outside customers is $2 per unit. These packing and shipping costs would not have to be incurred on sales of the parts to Division Y.

Required:

a. What is the range of transfer prices within which both the Divisions' profits would increase as a result of agreeing to the transfer of 7,000 parts this year from Division X to Division Y? (Round your final answers to 2 decimal places.)

b. Is it in the best interests of the overall company for this transfer to take place?

• Yes

• No

Answer 1

A. Calculation Of transfer of Range Price.

From the perspective of Division X, profits would increase as a result of the transfer if and only if:

Transfer price > Variable cost + Opportunity cost.

The opportunity cost is the contribution margin on the lost sales, divided by the number of units transferred.

Here Lost sale of Department Y = Total Expected Sale - Units Available for sale after Tranfer to department X

Lost sale = 25,200 - ( 28,000- 7000)  

Lost sale = 4,200 units.

So Opportunity Cost = [(46-35-2)*4200] / 7000 = $5.40 per Unit.

Therefore Minimum Transfer Price = 35 + 5.40 = $40.40 per Unit.

From the viewpoint of Division Y, the transfer price must be less than the cost of buying the units from the outside supplier. Therefore,Transfer price < $43.00.

After Analysing Both the Condition We found the following Range of Price.

$40.40 < Transfer Price < $43.00

B. Yes, the transfer should take place. From the viewpoint of the entire company, the cost of transferring the units within the company is $40.40, but the cost of purchasing them from the outside supplier is $43.00. Therefore, the company's profits increase on average by $2.60 for each of the special parts that is transferred within the company.