Tulip Company is made up of two divisions: A and B. Division A
produces a widget that Division B uses in the production of its
product. Variable cost per widget is $1.35; full cost is $2.20.
Comparable widgets sell on the open market for $2.90 each. Division
A can produce up to 2.60 million widgets per year but is currently
operating at only 50 percent capacity. Division B expects to use
130,000 widgets in the current year.
Required:
1. Determine the minimum and maximum transfer
prices.
2. Calculate Tulip Company’s total benefit of
having the widgets transferred between these divisions.
3. If the transfer price is set at $1.35 per unit,
determine how much profit Division A will make on the transfer.
Determine how much Division B will save by not purchasing the
widgets on the open market.
4. If the transfer price is set at $2.90 per unit,
determine how much profit Division A will make on the transfer.
Determine how much Division B will save by not purchasing the
widgets on the open market.
5. What transfer price would you recommend to
split the difference?
1.Since there is spare capacity, relevant cost is the variable cost as fixed costs do not change within the relevant range.
Hence, minimum price = variable cost per unit
= $1.35 per widget
Maximum price = Market price i.e. $2.90 per unit
2.Total benefit = (Market price – variable cost)
= (2.90-1.35)*130,000
= $201,500
3.Profit of Division A = (1.35-1.35)*130,000 = $0
Savings of Division B = (2.90-1.35)*130,000 = $201,500
4.Profit of Division A = (2.90-1.35)*130,000
= $201,500
Savings of Division B = $0
5. Recommended price = 1.35 + (2.90-1.35)/2 = 2.125 per unit
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