Question

Shaw is a lumber company that also manufactures custom cabinetry. It is made up of two divisions: Lumber and Cabinetry. The Lumber Division is responsible for harvesting and preparing lumber for use; the Cabinetry Division produces custom-ordered cabinetry. The lumber produced by the Lumber Division has a variable cost of $2.90 per linear foot and full cost of $3.90. Comparable quality wood sells on the open market for $8.70 per linear foot. (Enter your answers to 2 decimal places.)

Required:
1. Assume you are the manager of the Cabinetry Division. Determine the maximum amount you would pay for lumber.

Maximum Price

2. Assume you are the manager of the Lumber Division. Determine the minimum amount you would charge for the lumber if you have excess capacity. Repeat assuming you have no excess capacity

   Minimum Price with Excess Capacity:

Minimum Price without Excess Capacity:

3. Assume you are the president of Shaw. Determine a mutually beneficial transfer price assuming there is excess capacity.

Mutually Beneficial Transfer Price:

Answer 1

1. As manager of the Cabinetry Division, the maximum amount that can be paid should not exceed the price on the open market, i.e $ 8.70 per linear foot.

2. Minimum transfer price for the selling division = Variable Cost per Unit + Opportunity Cost of Lost Contribution Margin

As manager of the Lumber Division, minimum amount to be charged for the lumber:

a. If there is excess capacity, there would be no opportunity cost of lost sales to regular outside customers.

Therefore, the minimum price to be charged per linear foot = $ 2.90 + $ 0 = $ 2.90.

( Full cost will not be considered as it includes allocated fixed cost, and fixed cost is not relevant)

b. If there is no excess capacity, there is opportunity cost of lost sales to regular outside customers.

Hence, the minimum price to be charged per linear foot = $ 2.90 + $ ( 8.70 - 2.90) = $ 8.70.

3. The mutually beneficial transfer price, if there is excess capacity :

$ 2.90 >Transfer Price < $ 8.70

I would go for the midpoint , i.e $ ( 2.90 + 8.70) / 2 = $ 5.80 per linear foot. So neither he selling division manager nor the bying division manager can complain.