Question

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		54,000		292,000		103,000			201,000
Number of units now being sold to outside customers		54,000		292,000		79,000			201,000
Selling price per unit to outside customers	$	96	$	42	$	67		$	48
Variable costs per unit	$	61	$	19	$	42		$	34
Fixed costs per unit (based on capacity)	$	20	$	8	$	23		$	10
Beta Division:
Number of units needed annually		10,200		69,000		18,000			64,000
Purchase price now being paid to an outside supplier	$	87	$	39	$	67	*		—

*Before any purchase discount.

Managers are free to decide if they will participate in any internal transfers. All transfer prices are negotiated.

1. Refer to case 1 shown above. Alpha Division can avoid $5 per unit in commissions on any sales to Beta Division.

	Identify the lowest and highest acceptable transfer prices: Lowest acceptable transfer price ? Highest acceptable transfer price ? ? ≤ Transfer price ≤ ? Will the managers agree to the trade? Yesradio button unchecked1 of 2 Noradio button unchecked2 of 2

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.

	Identify the lowest and highest acceptable transfer prices: Lowest acceptable transfer price ? Highest acceptable transfer price ? ? ≤ Transfer price ≤ ? Loss in potential profits for the company ?

Answer 1

transfer price depends upon various factors like available production capacity, free capacity available,variable cost of production,opportunity cost. The transfer price is not beyond the variable cost of production otherwise company would occur loss.

(1) lowest acceptable price in case 1 will be the selling price to regular customer - avoidable cost

here the capacity of production is fully utilized in selling to regular customers, so in order to avoid loss

transfer price minimum should be ($96-5 avoidable sales commission)

Minimum=$91

Maximum would be the price at which the product is bought from outside supplier.

Beta division would not be ready to pay more than what it pays to outside supplier i.e. $87

Maximum price = $87

Identify the lowest and highest acceptable transfer prices:
	Lowest acceptable transfer price			$91
	Highest acceptable transfer price			$87
	$91	≤	Transfer price	≤	$87

There is no possible range between two division as alpha division wont sell below $91 and Beta division will not buy

above $87.

Will the managers agree to the trade?

NO

(2)

lowest acceptable price in case 2 will be the selling price to regular customer - avoidable cost

here the capacity of production is fully utilized in selling to regular customers, so in order to avoid loss

transfer price minimum should be ($42-$5 avoidable shipping cost)

Minimum=$37

Maximum would be the price at which the product is bought from outside supplier.

Beta division would not be ready to pay more than what it pays to outside supplier i.e. $39

Maximum price = $39

Identify the lowest and highest acceptable transfer prices:
	Lowest acceptable transfer price			$37
	Highest acceptable transfer price			$39
	$37	≤	Transfer price	≤	$39

if alpha division offers to sell 69000units to beta division at $37 but Beta division does not accept there will be potential loss for

[69000 units *($39-$37)]

=$138,000