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.

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

Sako Company’s Audio Division produces a speaker that is used by manufacturers of various audio products. Sales and cost data on the speaker follow:

Sako Company’s Audio Division produces a speaker that is used by manufacturers of various audio products. Sales and cost data on the speaker follow:

Selling price per unit on the intermediate market	$	43
Variable costs per unit	$	18
Fixed costs per unit (based on capacity)	$	7
Capacity in units		64,000

Sako Company has a Hi-Fi Division that could use this speaker in one of its products. The Hi-Fi Division will need 10,000 speakers per year. It has received a quote of $33 per speaker from another manufacturer. Sako Company evaluates division managers on the basis of divisional profits.

Required:

1. Assume the Audio Division is now selling only 54,000 speakers per year to outside customers.

a. From the standpoint of the Audio Division, what is the lowest acceptable transfer price for speakers sold to the Hi-Fi Division?

b. From the standpoint of the Hi-Fi Division, what is the highest acceptable transfer price for speakers acquired from the Audio Division?

c. What is the range of acceptable transfer prices (if any) between the two divisions? If left free to negotiate without interference, would you expect the division managers to voluntarily agree to the transfer of 10,000 speakers from the Audio Division to the Hi-Fi Division?

d. From the standpoint of the entire company, should the transfer take place?

2. Assume the Audio Division is selling all of the speakers it can produce to outside customers.

a. From the standpoint of the Audio Division, what is the lowest acceptable transfer price for speakers sold to the Hi-Fi Division?

b. From the standpoint of the Hi-Fi Division, what is the highest acceptable transfer price for speakers acquired from the Audio Division?

 

c. What is the range of acceptable transfer prices (if any) between the two divisions? If left free to negotiate without interference, would you expect the division managers to voluntarily agree to the transfer of 10,000 speakers from the Audio Division to the Hi-Fi Division?

d. From the standpoint of the entire company, should the transfer 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

Because there is enough idle capacity to fill the entire order from the Hi-Fi Division, no outside sales are lost. And because the variable cost per unit is $18, the lowest acceptable transfer price as far as the selling division is concerned is also $18.

Transfer price ≥ $18 +	0	= $18
	10,000

b.

The Hi-Fi division can buy a similar speaker from an outside supplier for $33. Therefore, the Hi-Fi Division would be unwilling to pay more than $33 per speaker.

Transfer price ≤ Cost of buying from outside supplier = $33

c.

Combining the requirements of both the selling division and the buying division, the acceptable range of transfer prices in this situation is:

$18 ≤ Transfer price ≤ $33

Assuming that the managers understand their own businesses and that they are cooperative, they should be able to agree on a transfer price within this range and the transfer should take place.

d.

From the standpoint of the entire company, the transfer should take place. The cost of the speakers transferred is only $18 and the company saves the $33 cost of the speakers purchased from the outside supplier.

 

2.

a.

Each of the 10,000 units transferred to the Hi-Fi Division must displace a sale to an outsider at a price of $43. Therefore, the selling division would demand a transfer price of at least $43. This can also be computed using the formula for the lowest acceptable transfer price as follows:

Transfer price ≥ $18 +	($43 − $18) × 10,000
	10,000

=	$18 + ($43 − $18) = $43

b.

As before, the Hi-Fi Division would be unwilling to pay more than $33 per speaker.

c.

The requirements of the selling and buying divisions in this instance are incompatible. The selling division must have a price of at least $43 whereas the buying division will not pay more than $33. An agreement to transfer the speakers is extremely unlikely.

d.

From the standpoint of the entire company, the transfer should not take place. By transferring a speaker internally, the company gives up revenue of $43 and saves $33, for a loss of $10.

Thanks