Question

Freight industries has several divisions. The Eastern Division can produce 3,000 units of product X at the following costs: $75/unit variable costs and $70/unit fixed costs. Eastern sells units of X in the outside market for $180/unit. The Canadian Division can use product X in its manufacturing process. If Canadian spends $80 of variable cost per unit to process X further, it can sell the resulting product Y for $200/unit.

Canadian can acquire product X from an outside supplier for $100 per unit.

Required: Answer the following independent questions.

1. If the Eastern division is operating at capacity and the Canadian division needs 100 units of product X, what is the lowest transfer price will Eastern accept?

2. If the Eastern division has a capacity of 2,000 units but can only sell 1,800 units of product X to outsiders, what is the lowest transfer price Eastern will accept for the sale of 100 units to the Canadian division? What is the highest transfer price Canadian will pay?

3. Assume the same situation as question 2. What is the optimal transfer price from the point of view of Freight Industries?

4. Calculate the contribution margins of Eastern and Canadian divisions assuming the situation described in question 2 with transfers at the optimal price. How much better off is Freight Industries if the internal transfer is made as opposed to the Canadian division buying the 100 units from outside suppliers? Explain your answer.

Answer #1

1)

Lowest transfer price = variable cost + opportunity cost of lost sales

Therefore,

Variable cost =$75

No lost sales here

Lowest transfer price =75 per unit

=75*100

=$7500

2)

Lowest transfer price is same in this case also, as there is no lost sales

Lowest transfer price =75*100

=$7500

And the highest transfer price is the market price that which is paid to the outside suppliers

Highest transfer price =$100

3)

Optimal transfer price =SUM of two divisional profits

Particulars |
Eastern division |
Canadian division |

Selling price per unit | 180 | 200 |

(-) Variable costs | 75 | 80 |

(-) fixed costs | 70 | - |

Divisional profit | 35 | 120 |

Optimal price | 35+120 | =155 |

Therefore, optimal profit of freight industries =155 per unit

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