2. Mercury Corporation manufactures car audio systems. It is a division of Count

Question

2. Mercury Corporation manufactures car audio systems. It is a division of Country-Wide Motors, which manufactures vehicles. Mercury sells car audio systems to other divisions of Country-Wide, as well as to other vehicle manufacturers and retail stores: The following information is available for Mercury's standard unit: variable cost per unit $31, fixed cost per unit $23, and selling price to outside customer $85. Country-Wide currently purchases a standard unit from an outside supplier for $80. Because of quality concerns and to ensure a reliable supply, the top management of Country-Wide has ordered Mercury to provide 200,000 units per year at a trapsfer price of $30 per unit. Mercury is already operat- ing at full capacity. Mercury can avoid $2 per unit of variable selling costs by selling the unit internally Instructions (a) What is the minimum transfer price that Mercury should accept? (b) What is the potential loss to the corporation as a whole resulting from this forced transfer? (c) How should the company resolve this situation?

Explanation / Answer

(a) Since we can See that Mercury sells its product to outsiders at Rs 85/-. It should not compromise with the profit of its own division. However, by selling the product internally, the division actually saves $2 per unit(Variable Cost), therefore, the division should accept at: 85-2=$83 as minimum price, because lower than this, would lower the mercury's margin.
(b)We need to look at the company as a Whole for this problem.
Profit from the forced transfer= 80-30=$50(because earlier the company used to buy the product from outside at $80 and now paying only $30 to mercury)
Loss from the Forced transfer(or we can say loss to mercury)= 85-2-30=$53(The mercury should have sold at 85-2=$83 to keep the margin at same level, but now is being paid only $30, and hence incurring loss of $53)
Potential Loss= Loss from Transfer- Profit from Transfer
i.e. 53-50= 3
3*200000=$600000 Loss
(c)The Company should pay the minimum transfer price calculated in (a) i.e. $83

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