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: 52,000 306,000 103,000 203,000 52.000 306.000 26.000 203,000 Alpha Division Capacity in units Number of units now being sold to outside customers Selling price per unit to outside customers Variable costs per unit Fixed costs per unit (based on capacity) Beta Divisioni Number of units needed annually Purchase price now being paid to an outside supplier 9.600 69.000 22,000 58,000 *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 $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 two divisional managers over what the exact transfer price should be? d. Assume Alpha Division offers to sell 69.000 units to Beta Division for $39 per unit and that Beta Division refuses this price be the loss in potential profits for the company as a whole?

Answer 1

1
a.	Lowest acceptable transfer price=Variable cost+(Contribution lost on lost sales)/Number of units transferred=(63-5)+[(98-63)*9600]/9600=58+35=$ 93
b.	Highest acceptable transfer price=Purchase price from outside supplier=$ 88
c.	For alpha division,Lowest price is $ 93
	For beta,Highest price is $ 88
	There will be no agreement between the divisions
2
a.	Lowest acceptable transfer price=Variable cost+(Contribution lost on lost sales)/Number of units transferred=(20-5)+[(42-20)*69000]/69000=15+22=$ 37
b.	Highest acceptable transfer price=Purchase price from outside supplier=$ 40
c.	For alpha division,Lowest price is $ 37
	For beta,Highest price is $ 40
	There will be an agreement between the divisions
	Range-$ 37 to $ 40
d.					$
	Purchase price from outside supplier				40
	Less: Variable cost on internal transfer				37
	Contribution margin lost by the company				3
					*
	Number of units transferred				69000
					=
	Loss in potential profits				207000
3
a.	Lowest acceptable transfer price=Variable cost+(Contribution lost on lost sales)/Number of units transferred
	Contribution lost on lost sales=0 since the company has enough capacity to produce 22000 units
	Lowest acceptable transfer price=$ 40
b.	Highest acceptable transfer price=Purchase price from outside supplier=67*(100%-7%)=67*93%=$ 62.31
c.	For alpha division,Lowest price is $ 40
	For beta,Highest price is $ 62.31
	There will be an agreement between the divisions
	Range-$ 40 to $ 62.31
d.	ROI=Margin*Turnover
	Since it has enough capacity to produce 22000 units,Margin and turnover will increase
	Hence,ROI also will be increased
4	Lowest acceptable transfer price=Variable cost+(Contribution lost on lost sales)/Number of units transferred=21+[(44-27)*29000]/58000=21+(17*29000)/58000=21+8.5=$ 29.5