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		52,000		289,000		104,000			206,000
Number of units now being sold to outside customers		52,000		289,000		79,000			206,000
Selling price per unit to outside customers	$	97	$	41	$	65		$	44
Variable costs per unit	$	61	$	19	$	41		$	28
Fixed costs per unit (based on capacity)	$	22	$	11	$	23		$	6
Beta Division:
Number of units needed annually		10,600		69,000		22,000			60,000
Purchase price now being paid to an outside supplier	$	89	$	40	$	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 $5 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 69,000 units to Beta Division for $39 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 3% 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 22,000 units from Alpha Division at $58.05 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 60,000 units of a different product from the one Alpha Division is producing now. The new product would require $23 per unit in variable costs and would require that Alpha Division cut back production of its present product by 30,000 units annually. What is the lowest acceptable transfer price from Alpha Division’s perspective?

Answer 1

CASE 1   

Contribution per unit = Selling price per unit - variable cost per unit

                                    = $97 - $59               =$38

Variable cost saving + $59 - $5 = $54

Transfer price = variable cost per unit + ( total contribution margin given up on lost sales/ units trfd)

a) transfer price = $54 + 38* 9400/9400

                          = $92

b) contribtuon margin was $38

now under transfer             $38          ( $92 - $54)

Thus indifferent to selling outside or transfer

BETA div

                cost per uint purchased outside                 $89

             cost per unit of trfd                                         $92

Div b manager would reject                                       $3    higher price

c) no the managers will not agree as Alpha will not want anything less than $92 and beta will not pay any thing more than $89

CASE2

contribution per unit = $42-$21 = $21

Transfer pricing = ( $21 - $4 saving in shipping cost ) + 21 = $38

Alpha is earning same contribution as earlier $38 - $17 = $21 hence indifferent

BETA  

Cost per unit if purchased         $40

transfer price                               $38

Saving of thus $2

c) the managers should agree

Alpha sells 70,000 units to beta div for $39 per unit

potential loss = 70,000 * 2 = $140,000

( since A will lose $1 since it could have got $40 at which beta purchase from outside - and Beta will have to pay $ 1 more since it can get the samae at $38 from Alpha )

CASE3

Beta is recieving 4% price discount = $69 @96% = $66.24

Div A  

Transfer price = $43 + 0 = $43

since no contribution is lost

Alpha no difference

BETA DIV

cost per unint if purchased outsied              $66.24

transfer price                                                  $43

Saving in cost                                               $23.24

b) BETa div offet to purchase 22000 units from Alpha at $61.24

benefit to whole company 22000 * 23.24 = $ 511,280

Alpha $61.24 - $43 = $18.24 contribution     =     $18.24 * 22000 = $401,280)

Effect on ROI = Division income will increase by $ 401,280 with no changes in investmetn , thus ROI will increase

BETA=( 66.24 - 61.24 = 5 *22000 = 110,000

CASE4   66000 units .; 30 variable cost ; 33000 units capacity reduction

transfer price = $33 + ( $14 * 33000/66000) = $33 +$7 = $40