Question

Giga-Stuff, Inc. has a number of divisions. One division, Sophistosand, makes a component, component X, that is used in the manufacture of CD players. Another division, Videostuff, makes DVD players that use component X adn needs 60,000 units of component X per year. Sophistosand incurs the following costs for one unit of component X:

Direct Materials: $0.30

Direct Labor: $0.15

Variable OH: $0.70

Fixed OH: $1.00

Sophistosand has capacity to make 400,000 units of component X per year, but due to a soft market, only plans to produce adn sell 320,000 units next year. Videostuff currently buys a component X from an outside supplier for $2.50 each (the same retail price that Sophistosand receives.)

1. Assume that Giga-stuff allows negotiated transfer pricing. What is the flooe of the bargaining range and which division sets it? In other words, What is the low price in the transfer matric and does the buyer or seller sell it?

2. What is the maximum transfer price per unit and does Videostuff or Sophistosand set it?

3. Assume that Sophistosand and Vdeiostuff have agreed on a transfer price of $2.20. How much better or worse off would Videostuff be? Your answer should include the unit dollar amount and whether Videostuff is better or worse.

4. At the transfer price of $2.20, how much better off or worse is Sophistosand?

5. How much better off would the company be as a whole if one unit is transferred internally at $2.20?

Answer 1

Pease see the image below first.

Now below are the answers

1. If the component x is produced internally then this will save the company cost. If negotiation is allowed then Sophistosand will set the price at which the component X is to be transferred.

The lowest price will be the cost at which Sophistosand can make one unit of component X and the lowest price is $2.20

2. The maximum price cannot exceed the rate at which the component can be purchased from the outside vendors. The max price will be $2.50

3. If the transfer price is agreed at $2.20 then Vdeiostuff will save $.30 per unit of x

4. At the transfer price of $2.20 Sophistosand would only be able to cover up the cost and there will be no profit and no loss.

5. The company will save $.30 per unit of X if this is produced internally as they are purchasing this from outside vendor @$2.50.