Question

1. The following information concerns two business units within an organization:

Division A currently sells its product to outside parties at a price of $20 per unit. It incurs variable costs of $7 per unit and fixed costs of $50,000 per month. Monthly production is typically 10,000 units, and the division purchases no materials internally.

                               

Division B can use the product that Division A produces as a raw material in its operations. If Division B purchases the units from Division A, Division B would need to pay $1.50 per unit in shipping costs to an outside freight company. Alternatively, Division B can buy the units from a separate outside vendor at a delivered price of $21 per unit. Either way, Division B plans on meeting the demand of all its customers. The two divisions are trying to work out a mutually agreeable transfer price, and have agreed that incremental costs do not include fixed costs.

1. Assume division A has ample idle capacity.

1. Determine the INCREMENTAL cost PER UNIT of the organization as a WHOLE if Division B purchases the units INTERNALLY.

2. Determine the OPPORTUNITY cost PER UNIT of Division A if Division B purchases the units INTERNALLY

Answer 1

1) Incremental cost per units of the organisarion as a whole if Division B purchases the units internally =

variable Cost of A + Shipping Charges paid by B

= $ 7 + $ 1.5

= $ 8.5

2) Opprtunity cost per unit of Division A

Opprtunity cost is the loss of other alternative if one alternative is choosen. Since A has ample idel capacity, there is no profit is sacrificing by selling units to B. Hence opportunity cost is Zero

If A corporation do not have any idle capacity than opportunity cost will be ($20 - $7 = $13)

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