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:

	Case
	1		2		3			4
Alpha Division:
Capacity in units		54,000		292,000		103,000			201,000
Number of units now being sold to outside customers		54,000		292,000		79,000			201,000
Selling price per unit to outside customers	$	96	$	42	$	67		$	48
Variable costs per unit	$	61	$	19	$	42		$	34
Fixed costs per unit (based on capacity)	$	20	$	8	$	23		$	10
Beta Division:
Number of units needed annually		10,200		69,000		18,000			64,000
Purchase price now being paid to an outside supplier	$	87	$	39	$	67	*		—

*Before any purchase discount.

Managers are free to decide if they will participate in any internal transfers. All transfer prices are negotiated.

3. Refer to case 3 shown above. Assume that Beta Division is now receiving an 4% price discount from the outside supplier.

	Identify the lowest and highest acceptable transfer prices: Lowest acceptable transfer price ? Highest acceptable transfer price ? ? ≤ Transfer price ≤ ?

4. Refer to case 4 shown above. Assume that Beta Division wants Alpha Division to provide it with 64,000 units of a different product from the one Alpha Division is producing now. The new product would require $30 per unit in variable costs and would require that Alpha Division cut back production of its present product by 32,000 units annually. What is the lowest acceptable transfer price from Alpha Division’s perspective?

	Lowest acceptable transfer price

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Answer 1

3. Since there is excess capacity available in alpha division it won't have to sacrifice any profit also there will be no change in fixed cost. So only variable cost will be relevant.

Alpha will be ready to transfer at minimum variable cost.

Beta will ready to buy maximum at market price less discount

So maximum Price = $67 - 4% = $64.32

Minimum price = $42

Transfer price will be between $42 to $64.32

4. Since he has to cut existing production hence contribution foregone is also relevant.

Existing profit on these 32000 units

= 32000*($48-34)

= $448000

Hence lowest acceptable price

= Variable cost + profit foregone

= $30 + ($448000/64000)

= $37

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