Question

A multinational company has many divisions. Two of these divisions are Mic Division and Mandy Division. The Mic Division produces a component that is used by the Mandy Division. The cost of manufacturing the component is as follows:

Direct materials	$10
Direct labour	$6
Variable overhead	$4
Fixed overhead	$5*
Total cost	$25

*Based on a normal volume of 400,000 components

Other costs incurred by the Mic Division are as follows: Fixed selling and administrative: $400,000
Variable selling: $1.50 per unit

Mic Division has been selling its manufactured component for $40 in the external market. The Mic Division is capable of producing 500,000 components per year. However, the division expects to be only able to sell 400,000 components next year. The variable selling expenses are avoidable if the component is transferred internally.

Mandy Division has been buying a very similar component from an external supplier at $34 per unit. The division expects to use 100,000 units of this component next year. The manager of the Mandy Division has offered to buy 100,000 units from the Mic Division at $24 per unit.

Required:

(a) Compute the minimum transfer price that the Mic Division would be willing to accept.

(b) Compute the maximum transfer price that the Mandy Division would be willing to pay.

(c) What will be the effect on company-wide profit if 100,000 components are transferred internally, at a price of $24 per unit, instead of Mandy Division buying at $34 per unit from the external supplier?

(d) Assume that Mandy Division has decided to expand its production volume, and will now require 200,000 units of the component. Advise the CEO of the company on setting corporate policies with respect to internal transfers between Mic and Mandy divisions. Support your answer with relevant computations.

Answer 1

Answer :

a Minimum acceptable price per unit $             20

b Maximum acceptable price per unit to Mandy Division = $             34

c Increase in company's profits $ 1,400,000

d CEO is advised that 100,000 units should be transferred by Mic division and remaining 100,000 units

should be purchased from external supplier.

Explanation :

Steps and calculations are shown below so you will understand how to reach to answer;

a Step 1 Calculate minimum acceptable transfer price to Mic Division

Minimum acceptable price is variable manufacturing cost

Direct material $10

Direct labor $6

Variable overhead $4

Minimum acceptable price per unit $20

b Maximum transfer price that the Mandy Division would be willing to pay is price at which it is purchasing from market

Maximum acceptable price per unit to Mandy Division = $34

c Step 2 Calculate effect on company profits

Units to be transferred 100,000

Buying cost saved $3,400,000 =100000*34

Less Variable cost of manufacturing $2,000,000 =100000*20

Increase in company's profits $1,400,000

d CEO is advised that 100,000 units should be transferred by Mic division and remaining 100,000 units

should be purchased from external supplier.