Question

Fyodor Corporation has a Parts Division that does work for other Divisions in the company as well as for outside customers. The company's Machine Division has asked the Parts Division to provide it with 7200 special parts each year. The special parts would require $27 per unit in variable production costs.

The Machine Division has a bid from an outside supplier for the special parts at $39.30 per unit. In order to have time and space to produce the special part, the Parts Division would have to cut back production of another part-the QR4 that it presently is producing. The QR4 sells for $52 per unit, and requires $26 per unit in variable production costs. Packaging and shipping costs of the QR4 are $2 per unit. Packaging and shipping costs for the new special part would be only $0.50 per unit. The Parts Division is now producing and selling 36,000 units of the QR4 each year. Production and sales of the QR4 would drop by 5% if the new special part is produced for the Machine Division.

Required:

Please calculate the following:

Fyodor Parts Division Selling transfer price (rounded to 2 decimal places)	$
Fyodor Machine Division Buying Transfer price (rounded to 2 decimal places)	$
Should the transfer take place (Yes or No)

Answer 1

(1) from the view of parts division profit will increase when transfer price >variable cost+opportunity cost

opportunity costs here would be contribution margin on sales lost divided by number of units to be transferred

opportunity cost = [$52-$26-$2]* (36000*5% drop) / 7200 parts to b e transferred

$24*1800 /7200

=$6

transfer price $\geq$ ($27+$0.50) + ($6)

=$33.5

therefore Fyodor Parts Division Selling transfer price (rounded to 2 decimal places) is $33.5

(2) from point of view of machine division transfer price must be less than the cost of buying part from outside supplier i.e. $39.30

Fyodor Machine Division Buying Transfer price <$39.30

(3) the range of transfer price should be between $33.50 - $39.30

yes the transfer should take place.

the cost of transferring within the company is $ 33.50 however cost of buying from outside supplier is $39.30, so if internal transfer takes place there will be cost saving of (39.30-33.5) $5.8 per part, which is beneficial for the entire company.