Question

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:

	Case
	1		2		3			4
Alpha Division:
Capacity in units		53,000		301,000		103,000			202,000
Number of units now being sold to outside customers		53,000		301,000		79,000			202,000
Selling price per unit to outside customers	$	99	$	41	$	66		$	48
Variable costs per unit	$	60	$	21	$	42		$	34
Fixed costs per unit (based on capacity)	$	23	$	7	$	23		$	9
Beta Division:
Number of units needed annually		10,700		67,000		21,000			56,000
Purchase price now being paid to an outside supplier	$	91	$	41	$	66	*		—

*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 $5 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 $4 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?

d. Assume Alpha Division offers to sell 67,000 units to Beta Division for $40 per unit and that Beta Division refuses this price. What will be the loss in potential profits for the company as a whole?

3. Refer to case 3 shown above. Assume that Beta Division is now receiving an 3% price discount from the outside supplier.

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?

d. Assume Beta Division offers to purchase 21,000 units from Alpha Division at $59.02 per unit. If Alpha Division accepts this price, would you expect its ROI to increase, decrease, or remain unchanged?

4. Refer to case 4 shown above. Assume that Beta Division wants Alpha Division to provide it with 56,000 units of a different product from the one Alpha Division is producing now. The new product would require $29 per unit in variable costs and would require that Alpha Division cut back production of its present product by 28,000 units annually. What is the lowest acceptable transfer price from Alpha Division’s perspective?

Answer 1

1. (a) Alpha Division is making full utilization of its capacity. Hence it is a profit making unit. Lowest transfer price from Alpha prespective is

Selling Price to outside customer = $99

Savings in cost if sales is made to Beta = $5

Minimum transfer price to Beta = $99 - $5 i.e. $94

1. (b) Beta will purchase from Alpha only if Alpha will provide the required material at a price equal to or less than the current purchase cost. Therefore, maximum transfer price from the prespective of Beta is $91.

1. (c) The Alpha Division can transfer at a minimum price of $94 however Beta can accept transfer at a maximum price of $91. Therefore, there will be no acceptable transfer price range between the two divisions and the manager will not agree to transfer.

2. (a) Alpha Division is making full utilization of its capacity. Hence it is a profit making unit. Lowest transfer price from Alpha prespective is

Selling Price to outside customer = $41

Savings in shipping cost if sales is made to Beta = $5

Minimum transfer price to Beta = $41 - $4 i.e. $37

2. (b) Beta will purchase from Alpha only if Alpha will provide the required material at a price equal to or less than the current purchase cost. Therefore, maximum transfer price from the prespective of Beta is $41.

2. (c) The Alpha Division can transfer at a minimum price of $37 however Beta can accept transfer at a maximum price of $41. Therefore, the acceptable transfer price range between the two divisions shall be ($37 to $41). There is a negligible chance of conflict between the managers of both division regarding transfer price because there is a acceptable transfer price range where both the manager can earn a high profit for their division and the company as a whole.

2. (d) Loss to Alpha due to non acceptance of offer by Beta will be the loss of Potential Savings in shipping cost at transfer price of $40.

Potential loss of Savings of Shipping cost = Shipping cost per unit reduced by difference in sale price and transfer price * No. of units to be transferred

= [$4 - ($41 - $40)] * 67,000 units

= $201,000

3. (a) Alpha Division is not making full utilization of its capacity. Therefore, there is a spare capacity of 24,000 units (103,000 units - 79,000 units) in Alpha division. In case of spare capacity, the lowest price acceptable is the variable cost of manufacturing one unit i.e. $42 for the units to be manufactured in spare capacity. Hence, lowest acceptable price from Alpha prespective shall be $42 for the first 24,000 units to be transferred.

3. (b) Beta will purchase from Alpha only if Alpha will provide the required material at a price equal to or less than the current purchase cost. The purchase cost of Beta after receiving 3% discount will be $64.02 ($66 * 0.97). Therefore, maximum transfer price from the prespective of Beta is $64.02.

3. (c) The Alpha Division can transfer at a minimum price of $42 however Beta can accept transfer at a maximum price of $64.02. Therefore, the acceptable transfer price range between the two divisions shall be ($42 to $64.02). As there is an acceptable transfer price range, the managers will probably agree to a transfer.

3. (d) If Beta Division offers to purchase 21,000 units from Alpha Division at $59.02 per unit and Alpha accepts the price, ROI of both the divisions will increase because transfer price of $59.02 is within the acceptable transfer price range which implies that the profit of Alpha Division will increase due to sale of additional units at a price higher than variable costs and profits of Beta division will increase due to reduction of purchase cost as compared to the outside.

4. Fixed cost is relevant in this decision, hence, ignored.

Lowest acceptable transfer price = Loss of potential contribution + Cost involved in manufacturing of units to be transferred

Potential Contribution lost on 28,000 units = 28,000 units * ($48 - $34)

= $392,000

Contribution loss on each unit to be transferred to Beta = $392,000 / 56,000 units

= $7

Lowest acceptable transfer price = Loss of potential contribution + Cost involved in manufacturing of units to be transferred

= $7 + $29

= $36 per unit