Question

Problem 11A-6 Basic Transfer Pricing [LO11-5]

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		315,000		106,000			200,000
Number of units now being sold to outside customers		54,000		315,000		81,000			200,000
Selling price per unit to outside customers	$	100	$	40	$	63		$	47
Variable costs per unit	$	63	$	21	$	38		$	31
Fixed costs per unit (based on capacity)	$	26	$	8	$	21		$	9
Beta Division:
Number of units needed annually		10,600		75,000		20,000			62,000
Purchase price now being paid to an outside supplier	$	92	$	38	$	63	*		—

*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 $3 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 75,000 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 7% 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 20,000 units from Alpha Division at $53.59 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