4 Problem 11A-6 Basic Transfer Pricing [L011-5] 10 points Alpha and Beta are div

Question

4 Problem 11A-6 Basic Transfer Pricing [L011-5] 10 points Alpha and Beta are divisions within the same company. The managers of both divisions are evaluated based on their own division's return on investment (ROI). Assume the following information relative to the two divisions 02 43 25 Alpha Division: Capacity in units Number of units now being sold to 55,000 289,000 103,000 196,000 55,000 289,000 77,000 196,000 46 outside eustomers Selling price per unit to outside 99 $ $ 64 38 $ 18 S 68 $ 42 30 Variable costs per unit rixed costs per unit (based on Print capacity $ 24 $ 7 27 7 Beta Division Number of units needed annually Purchase price now being paid to 10.400 70,000 21,000 6,000 0 an outside supplier $ 92 3668 References Before any purchase discount Managers are free to decide if they will participate in any internal transfers. All transfer prices are negotiated. Required: 1. Refer to case 1 shown above. Alpha Division can avoid $4 per unit in commissions on any sales to Beta Division. a. What is the lowest acceptable transfer price from the perspective of the Alpha Division? b. What is the highest acceptable transfer price from the perspective of the Beta Division? c. What is the range of acceptable transfer prices (if any) between the two divisions? Will the managers probably agree to a transfer? 2. Refer to case 2 shown above. A study indicates that Alpha Division can avoid $5 per unit in shipping costs on any sales to Beta Division. a. What is the lowest acceptable transfer price from the perspective of the Alpha Division? b. What is the highest acceptable transfer price from the perspective of the Beta Division? c. What is the range of acceptable transfer prices (if any) between the two divisions? Would you expect any disagreement between the two divisional managers over what the exact transfer price should be?

Explanation / Answer

1 Case 1

.a Alpha division’s capacity is fully utilized. In order to supply to Beta division, it will need to divert from the existing customers.

Profit per unit from existing customers=($99-$64-$24)=$11

Reduction in cost for selling to Beta division=$4

Hence, minimum acceptable transfer price by Alpha division=(99-4)=$95

.b. Highest acceptable transfer price by Beta division=$92

.c The managers cannot agree to a transfer price .For any transfer price lower than $ 95, Alpha division will incur net loss and for any transfer price above $92 Beta division will incur loss

.2. Case 2

.a. Alpha division’s capacity is fully utilized. In order to supply to Beta division, it will need to divert from the existing customers.

Profit per unit from existing customers=($38-$18-$7)=$13

Reduction in cost for selling to Beta division=$5

Hence, minimum acceptable transfer price by Alpha division=(38-5)=$33

.b. Highest acceptable transfer price by Beta division=$36

.c Range of acceptable transfer price:$33 to $36 .

The managers can agree to a transfer price within the range of $33 to $36

.3. Case 3

.a. Alpha division’s capacity is not fully utilized. It can use extra capacity In order to supply to Beta division. It need not divert from the existing customers. Hence, extra sales will give the division additional profit

Marginal cost of Alpha division per unit=Variable cost=$42

Marginal revenue needs to be higher than the marginal cost to make additional profit.

Hence, minimum acceptable transfer price by Alpha division=$42

.b. Highest acceptable transfer price by Beta division=$68 – 3% discount=68*(1-0.03)=$65.96

.c Range of acceptable transfer price:$42 to $65.96 .

The managers can agree to a transfer price within the range $42 to $65.96

.4 Case 4

.a Alpha division’s capacity is fully utilized.

In order to produce a different product, it will need to incur additional fixed costs or cut back on the existing product.

Marginal income from existing product per unit=(46-30)=$16

Loss of income for cut back of existing product by 33,000 units=(33000*16)= $ 528,000

This amount need to be recovered from the new product.

Marginal income per unit from the new product required=( $ 528,000/66000)=$8

Marginal cost of new product=Variable cost=$27

Hence, minimum Revenue=(27+8)=$35

Hence, Lowest acceptable transfer price by Alpha division=$35

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