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		52,000		319,000		105,000			193,000
Number of units now being sold to outside customers		52,000		319,000		81,000			193,000
Selling price per unit to outside customers	$	95	$	40	$	66		$	48
Variable costs per unit	$	59	$	20	$	40		$	34
Fixed costs per unit (based on capacity)	$	21	$	7	$	23		$	10
Beta Division:
Number of units needed annually		10,100		68,000		20,000			56,000
Purchase price now being paid to an outside supplier	$	89	$	38	$	66	*		—

*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 $3 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 68,000 units to Beta Division for $37 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 6% 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 20,000 units from Alpha Division at $57.04 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 56,000 units of a different product from the one Alpha Division is producing now. The new product would require $29 per unit in variable costs and would require that Alpha Division cut back production of its present product by 28,000 units annually. What is the lowest acceptable transfer price from Alpha Division’s perspective?

Answer 1

	Solution 1A to 1C
A	Lowest Acceptable tranfer price	92	(Selling price to Outside customers - $3)
B	Highest Acceptable tranfer price	89	(Purchases price now paid to ouside supplier)
C	There is not a range of acceptable transfer Prices	No range
	Will the managers agree to the trade?	No
	Solution 2A to 2D
A	Lowest Acceptable tranfer price	35	(Selling price to Outside customers - $5)
B	Highest Acceptable tranfer price	38	(Purchases price now paid to ouside supplier)
C	There is a range of acceptable transfer Prices	35-38
	Will the managers agree to the trade?	Yes
D	Loss in potential profits of the company	204000	($38-35)*68000
	Solution 3A to 3D
A	Lowest Acceptable tranfer price	40	(Variable cost per unit)
B	Highest Acceptable tranfer price	62.04	(66*94%)
C	There is a range of acceptable transfer Prices	40 to 62.04
	Will the managers agree to the trade?	Yes
D	Division A's ROI should	Increase
	Solution 4:
	Lowest acceptable transfer price
	Contribution margin lost on present product	392000	[($48- $34)*28000]
	Varibal cost of New product	1624000	(56000*$29)
	Total Cost	2016000
	/ Units of new product	56000
	Lowest acceptable transfer price	36.00