Question

SPD Ltd has two divisions, Tomato Division and Canning Division. Tomato Division has an annual capacity of 10,000 units of tomato paste concentrate. Canning Division's annual requirement of tomato paste concentrate is 8,000 units. The variable production cost of one unit of tomato paste concentrate at Tomato Division is $6, but the division incurs $1 additional shipping cost per unit when selling to external suppliers. The market price for the division's tomato paste concentrate is $10 per unit, and currently, the external demand for Tomato Division's tomato paste concentrate is 5000 units.
Using the general transfer pricing formula, Tomato Division should charge the Canning Division:

		$6.00.
		$10.00.
		$7.13.
		$9.00.

Answer 1

Ans : Total Capacity of Tomato Division = 10,000 units
Requirement of Canning Division = 8,000 units
External Demand = 5000units

Thus of 10,000 units, 8000 units will be transferred to Canning Division and remaining 2000 will be sold in market.

Therefore, the possible gain that could have been earned if 3000 units (5000-2000) also  would have been sold in the market instead of transferring to Canning Division will be the opportunity cost for Tomato Division

Opportunity Cost = (Market Price - Variable Cost - Shipping Cost ) * 3000 units
= ($10 - $6 - $1 ) * 3000
= $9000

Opportunity cost for not selling in market is $9,000 which will be recovered by Tomato Divsion from Canning Division.

Opportunity Cost Charged on per unit to Canning Division = $9000 / 8000 units = $1.125 per unit

Transfer Price = Variable cost + Opportunity Cost
= $6 + $1.125
= $7.125 = ~$7.13

Ans : Tomato Division should Charge $7.13 from Canning Division.