Question

PROBLEM 131-4 Base Transfer Pricing |LDE] Alpha and Beta are divisions within the same company. The managers of both divisions are evalu ated based on their own division's return on investment (ROD). Assume the following information relative to the two divisions Case 400.000 400.000 150.000 100,000 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 Division Number of units needed annually.... Purchase price now being paid to an outside supplier. .... B0,000 90.000 $30 $18 300 000 300,000 $50 $26 $75 $65 540 $15 $9 5,000 30,000 120,000 20,000 $75 $27 $09 "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 le case shown above. Ainha Division can avoid $2 per unit in commissions on any sales.to Beta Division. Will the managers agree to a transfer, and if so, within what range will the transfer price be? Explain. 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 Bela Division. Would you expect any disagreement between the two divisional managers over what the transfer price should be? Explain.

Answer 1

Case 1:

Existing

Selling Price	30
Less: variable Cost	18
Contribution	12

Since Internal transfer will reduce Sales commission by $ 2, The new variable cost will be 16 $ p u. Since entire production can be sold to outside market the manager of Alpha wont wish to have any loss of contribution. So minimum transfer price by Alpha = 16(Variable Cost) + 12 (minimum contribution) = 28$. However Beta wont accept for any price more than $ 27. So this transfer wont take place.

Case 2:

Selling Price	90
Less: variable Cost	65
Contribution	25

Since shipping cost of $ 5 will not be incurred, the new variable costs will be $ 60. Since entire production can be sold to outside market the manager of Alpha wont wish to have any loss of contribution. So minimum transfer price by Alpha = 60(Variable Cost) + 25(minimum contribution) = 85 $. Beta was paying $ 89 to the buyer. The transfer can take place.

So the transfer price range will be greater than or equal to $ 85 but more more 89 $.