Question

Pete’s Paint Company produces paint and has two divisions: Consumer and Commercial. Each division manager is evaluated based on profit produced by each division. The Commercial division sells paint to the Consumer division for $20 per gallon to cover variable costs. The Commercial division also sells to outside customers for $25 per gallon.

Required:

a. Using the general economic transfer pricing rule, calculate the optimal transfer price assuming the Commercial division is below capacity.
b. Using the general economic transfer pricing rule, calculate the optimal transfer price assuming the Commercial division is at capacity.

Answer 1

a) If commercial division is working below capacity transfer price = Variable cost = $20 per gallon

b) If commercial division is working at capacity then transfer price = $25 per gallon