Question

The following data apply to questions 5-9 The Santa Fe Manufacturing Company has two divisions in Kansas, the Holton Division and the Derby Division. Currently, Derby buys a part (10,000 units) from Holton for $16 per unit. Holton has purchased new equipment and wants to increase the price to Derby to $18 per unit. The controller of Derby claims that she cannot afford to go that high, as it will decrease the division's profit to near zero. Derby can buy the part from an outside supplier for $16 per unit. The incremental costs per unit that Santa Fe incurs to produce each unit are Holton's variable costs of $12. Fixed costs per unit for Holton with the recent purchase of equipment are $5.

Answer: A

the answer is A but can someone explain to me why? show yor work and thanks in advance!

Answer 1

Answer is A i.e. Holton Division will transfer at full cost of $17 ($12 Variable cost + $5 Fixed cost) because Derby Division is assumed to be located in England where tax rate 45%. Transfer price of Holton division can be considered purchase price for Derby Division and if purchase price will be higher than profit will be lower and Derby Division will have to pay lower tax and Company as a whole will be benefited.  

Sales

(-) Variable cost

= Contribution

(-) Fixed cost

= Profit

If variable cost (which includes purchase price of material) will be higher than Contribution will be lower and after deducting Fixed cost ultimate profit will be lower. Therefore resulting in less taxable profits for Derby division.

Hotlon Division will pay tax on units transfered @ 30% because it will be considered its sales

Derby Division will get tax benefit @ 45% as cost of material transfered will be deducted while calculating profits

Therefore, if transfer price is set as $17, it will result in Saving in taxes