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 | 100,000 | 108,000 | ||
| Number of units being sold to outside customers | 100,000 | 83,000 | ||
| Selling price per unit to outside customers | $ | 59 | $ | 33 |
| Variable costs per unit | $ | 25 | $ | 12 |
| Fixed costs per unit (based on capacity) | $ | 7 | $ | 5 |
| Division Y: | ||||
| Number of units needed for production | 25,000 | 25,000 | ||
| Purchase price per unit now being paid to an outside supplier | $ | 56 | $ | 24 |
Required:
1. Refer to the data in case A above. Assume in this case that $1 per unit in variable selling costs can be avoided 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?
Explanation
1.
a.
The lowest acceptable transfer price from the perspective of the selling division is given by the following formula:
| Transfer price ≥ | Variable cost per unit | + | Total contribution margin on lost sales |
| Number of units transferred |
There is no idle capacity, so each of the 25,000 units transferred from Division X to Division Y reduces sales to outsiders by one unit. The contribution margin per unit on outside sales is $34 ( = $59 – $25).
| Transfer price ≥ ($25 − $1) + | $34 × 25,000 |
| 25,000 |
| = | $24 + $34 = $58 |
b.
The buying division, Division Y, can buy a similar unit from an outside supplier for $56. Therefore, Division Y would be unwilling to pay more than $56 per unit.
Transfer price ≤ Cost of buying from outside supplier = $56
c.
There is no range of acceptable transfer prices. The requirements of the two divisions are incompatible and no transfer will take place.
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?
Explanation
2.
a.
In this case, Division X has enough idle capacity to satisfy Division Y’s demand. Therefore, there are no lost sales and the lowest acceptable price as far as the selling division is concerned is the variable cost of $12 per unit.
| Transfer price ≥ $12 + | $0 | = $12 |
| 25,000 |
b.
The buying division, Division Y, can buy a similar unit from an outside supplier for $24. Therefore, Division Y would be unwilling to pay more than $24 per unit.
Transfer price ≤ Cost of buying from outside supplier = $24
c.
As shown below, the range of acceptable transfer prices is $12 to $24. In this case, the requirements of the two divisions are compatible and a transfer hopefully will take place.
$12 ≤ Transfer price ≤ $24
Thanks
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