Question

Fyodor Corporation has a Parts Division that does work for other Divisions in the company as well as for outside customers. The company's Machine Division has asked the Parts Division to provide it with 11,600 special parts each year. The special parts would require $49 per unit in variable production costs.

The Machine Division has a bid from an outside supplier for the special parts at $69.00 per unit. In order to have time and space to produce the special part, the Parts Division would have to cut back production of another part-the QR4 that it presently is producing. The QR4 sells for $96 per unit, and requires $48 per unit in variable production costs. Packaging and shipping costs of the QR4 are $2 per unit. Packaging and shipping costs for the new special part would be only $0.50 per unit. The Parts Division is now producing and selling 58,000 units of the QR4 each year. Production and sales of the QR4 would drop by 5% if the new special part is produced for the Machine Division.

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 11,600 special parts per year from the Parts Division to the Machine Division?

Answer 1

First, we need to find out the minimum transfer price that Parts Division will require from Machine Division.

Minimum Transfer Price = Relevant Cost of Supplying 11,600 special parts to Machine Division.

i.e. Relevant Cost = Cost to be incurred + Benefit Lost

i.e. Relevant Cost = (Variable Production Cost of Special part + Packaging and Shipping Cost) + (Contribution lost of the part QR4)

i.e. Relevant Cost = [11,600 * (49 + 0.50)] + [5% of 58,000 * (96 - 48 - 2)]

i.e. Total Relevant Cost = $ 5,74,200 + 1,33,400 = $ 7,07,600

Thus, Minimum Transfer Price Per unit for Parts Division = $ 7,07,600 / 11,600 units = $ 61 per unit.

Now, Since Machine Division has a bid from an outside supplier for the special parts at $ 69 per unit, any rate less than $ 69 per unit will yield cost savings for Machine Division.

Hence, the Range of transfer price within which both the Divisions' profits would increase as a result of agreeing to the transfer of 11,600 special parts per year from the Parts Division to the Machine Division is $61 per unit to $69 per unit.