Question

You have been provided with the following information for Division X of a decentralized company:

Selling price	$	85
Variable cost per unit		61
Fixed cost per unit		26
Sales volume (units)		21,600
Capacity (units)		25,300

Division Y of the same company would like to purchase all of its units internally. Division Y needs 11,100 units each period and currently pays $79 per unit to an outside firm. What is the lowest price that Division X could accept from Division Y? (Assume that Division Y wants to use a sole supplier and will not purchase less than 11,100 from a supplier.)

Please show all of your work.

Answer 1

Minimum transfer price to other division is sum total of variable cost of production, additional fixed cost (if any) and loss of contribution on regular sales (If regular sales is cut to fulfil interdivision demand)

In the above case, Minimum transfer price will be variable cost of 11,100 units and contribution lost on sale of 7400 (11100-3700) units. Contribution will be lost on only the 7400 units because the company have an excess capacity of 3700 units.

Minimum transfer price calculation
Variable cost of 11100 units (11100 x $ 61)	$ 6,77,100.00
Loss of Contribution on 7400 Units (7400 x $ 24*)	$ 1,77,600.00
Total cost to be recovered	$ 8,54,700.00
Units to be sold	11,100
Minimum transfer price	$ 77.00

*Contribution margin = sales price– Variable cost per unit

Contribution margin =85-61