Question

Alex Ltd. produces kitchen tools, and operates several divisions as profit centers. Division M produces a product that it sells to other companies for $16 per unit. It is currently operating at its full capacity of 45,000 units per year. Variable manufacturing cost is $9 per unit, and variable marketing cost is $3 per unit.

           

            The company wishes to create a new division, Division N, to produce an innovative new tool that requires the use of Division M's product (or one very similar). Division N will product 30,000 units. Currently, Division N can purchase a product equivalent to Division M's from Company X for $15 per unit. However, Alex Ltd. is considering transferring the necessary product from Division M.

           

            Required:                   

            1)   Assume the transfer price is $12 per unit. How would this affect the purchasing costs of Division N? How would this affect the profits of Division M? How would this affect Max Ltd. as a whole?

            2.)   What if the transfer price was $13 per unit?

Answer 1

Answer to Question 1:

Question 1 Division N: Purchased from outside from Division M Difference $ 4,50,000 3,60,000 90,000 Purchased Cost$ Calculation (15*30,000) (12*30,000) Purchasing from Division M would result cost savings to Division N amounting to $ 90,000 Division M: Division M is operating at full capacity Sold Outside Sold to Division NDifference Margin Is 120,000 90,000 30,000 (16 -9 Calculation 3) 0000 (12 Selling to Division N would make Division M lose S 30,000 per year. As a whole, the company would save $ 60,000 ($ 90,000- 30,000) if transfer pricing @ $12 per unit was used. - 9)*30000

Answer to Question 2:

Question 2 Division N: Purchased Purchased from outside from Division M Difference 4,50,000 $ 3,90,000 $ Cost 60,000 Calculation (15*30,000) (13*30,000) Purchasing from Division M would result cost savings to Division N amounting to $ 60,000 Division M: Division M is operating at full capacity MarginS 1,20,000S 1,20,000 $ Calculation 3)*30000 (13 9)*30000 No Difference indicates that Division M would be indifferent about selling to outside customers versus transferring to Division N Sold Outside Sold to Division N Difference (16-9- As a whole, transferring pricing $13 per unit would save Max Ltd. $ 60,000