Question

Tulip Company is made up of two divisions: A and B. Division A produces a widget...

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?

Homework Answers

Answer #1

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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