Question

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		97,000		90,000
Number of units being sold to outside customers		97,000		69,000
Selling price per unit to outside customers	$	52	$	33
Variable costs per unit	$	26	$	17
Fixed costs per unit (based on capacity)	$	7	$	5
Division Y:
Number of units needed for production		21,000		21,000
Purchase price per unit now being paid to an outside supplier	$	45	$	34

Required:

1. Refer to the data in case A above. Assume in this case that $4 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?

Answer 1

1.a) Since Division X does not have spare capacity (Outside market demand = production capacity) in Case A, the lowest acceptable transfer price would be as follows:

Lowest acceptable transfer price = Selling price to outside customers - Variable selling costs saved due to intercompany sales

Lowest acceptable transfer price = $52 - $4 = $48

1.b) Highest acceptable transfer price from perspective of buying division, i.e., Division Y = Purchase price being paid to outside suppliers in Case A = $45

1.c) There is no range of acceptable prices between the divisons since the lowest acceptable selling price for Division A is $48 which is more than the highest acceptable purchase price for Division Y which is $45. Hence even if the managers are free to negotiate and make decisions on their own, no transfer will take place.