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A company produces a single product at two locations. Division A produces the product at a...

A company produces a single product at two locations. Division A produces the product at a constant marginal cost of $10 per unit and has additional capacity to spare. Division B is experiencing a significant manufacturing problem and is temporarily not able to produce. As a result, Division B would like to purchase units from Division A to satisfy its local demand, which is defined by the following demand curve: P = 110 - 5Q. As the CFO of the entire company who knows Division A's marginal cost and Division B's demand curve, (1) what transfer price will you set, and (2) at this price, how many units should Division B purchase?

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Answer #1

Marginal Cost of Supplying Division (Division A) is $10 per unit, which means Division A is not going to transfer the product at a price which is less than $10 to Division B.

Given Demand curve for Division B is P=110-5Q which means Maximum price that can be paid by Division B is where quantity is 0 units i.e., P = 110. And its Maximum demand is 110/5 = 22 units

(1) As Division A has additional capacity to meet the demand requirements of Division B without foregoing its own demand, optimal transfer price should be the marginal cost for Division A i.e., $10

(2) At this transfer price, Division B should purchase 20 units [(110 - 10) / 5] from Division A.

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