Question

Rapid Industries has multiple divisions. One division, Iron Products, makes a component that another division, Austin, is currently purchasing on the open market. Iron Products currently has a capacity to produce 510,000 components at a variable cost of $5.50 and a full cost of $9.00. Iron Products has outside sales of 480,000 components at a price of $14.00 per unit. Austin currently purchases 40,000 units from an outside supplier at a price of $11.00 per unit. Assume that Austin desires to use a single supplier for its component. a. What will be the effect on Rapid Industries’ operating profit if the transfer is made internally? Assume the 40,000 units Austin needs are either purchased 100% internally or 100% externally. b. What is the minimum transfer price? (Round your answer to 2 decimal places.) c. What is the maximum transfer price? (Round your answer to 2 decimal places.)

Answer 1

Iron products and Austin are the two divisions of Rapid Industries. Both the divisions are in the same country and are assumed to be controlled centrally. So it will be preferable for Austin to purchase the required product internally from Iron Products if it costs less than $11.00 per units.

a.) As it is said that the 100% purchase of 40,000 units by Austin will be made either internally or externally, The spare capacity of Iron Products is of only 30,000 units, that is 10,000 less than demanded. So the 30,000 units will be priced at Variable cost and remaining 10,000 units will be priced at Variable Cost plus Opportunity cost. The operating profit of Rapid Industries will get reduced by the amount of price difference between the Market Price and Negotiated Transfer Price.

b.) The Minimum Transfer Price should be Variable Cost, that is, $5.50 per unit if the Iron Products had the full spare capacity. But in the present case, it will be calculated as below,

[(30,000*5.50) + (10,000*14)] / 40,000 = $ 7.63 per unit.

c.) The Maximum Transfer price will be the market price of the product, that is, $14.