Question

In each of the cases below, assume Division X has a product that can be sold either to outside customers or to Division Y of the same company for use in its production process. The managers of the divisions are evaluated based on their divisional profits.

	Case
		A		B
Division X:
Capacity in units		105,000		93,000
Number of units being sold to outside customers		105,000		74,000
Selling price per unit to outside customers	$	57	$	28
Variable costs per unit	$	22	$	12
Fixed costs per unit (based on capacity)	$	10	$	5
Division Y:
Number of units needed for production		19,000		19,000
Purchase price per unit now being paid to an outside supplier	$	51	$	24

2. Refer to the data in case B above. In this case, there will be no savings in variable selling costs on intracompany sales.

a. What is the lowest acceptable transfer price from the perspective of the selling division?

b. What is the highest acceptable transfer price from the perspective of the buying division?

c. What is the range of acceptable transfer prices (if any) between the two divisions? If the managers are free to negotiate and make decisions on their own, will a transfer probably take place?

Answer 1

Case B:

A.

Spare capacity of division X = 93000-74000 = 19000 units.

The transfer price = variable cost per. Unit= 12$

[fixed costs are irrelevant or sunk cost].

So the minimum acceptable transfer price for division X = 12$

B.

Division Y 's highest acceptable transfer price = 24$ which it pays to outside suppliers, any price above 24$ will cause the Division Y to continue buy the product from outside.

C. The range of acceptable transfer prices = 12$ - 24$

If the managers are free to negotiate then any price higher than 12$ and below 24$ would increase the overall profitability of company.

Say at transfer price of 15$, Division X gets an additional contribution towards Fixed costs = (15-12)*19000= 57000$

Fixed costs are the same. So the additional profit from transfer = 57000$

Division Y also gains as the savings in cost of material = (24-15)*19000= 171000$

So that increases the overall profitability of company.

And the transfer will take place.