The Post Division of the M.T. Woodhead Company produces basic posts that can be sold to outside customers or sold to the Lamp Division of the M.T. Woodhead Company. Last year, the Lamp Division bought all of its 25,000 posts from the Post Division at $1.50 each. The following data are available for last year's activities of the Post Division:

The total fixed costs would be the same for all the alternatives considered below.
-Suppose the transfer of posts to the Lamp Division will cut into sales to outside customers by 15,000 units.What is the lowest transfer price that would not reduce the operating income of the Post Division?
A) $0.90.
B) $1.35.
C) $1.41.
D) $1.75.

Question

The Post Division of the M.T. Woodhead Company produces basic posts that can be sold to outside customers or sold to the Lamp Division of the M.T. Woodhead Company. Last year, the Lamp Division bought all of its 25,000 posts from the Post Division at $1.50 each. The following data are available for last year's activities of the Post Division:

The total fixed costs would be the same for all the alternatives considered below.
-Suppose the transfer of posts to the Lamp Division will cut into sales to outside customers by 15,000 units.What is the lowest transfer price that would not reduce the operating income of the Post Division?
A) $0.90. 
B) $1.35. 
C) $1.41. 
D) $1.75.

Quizplus · Accepted Answer

To determine the lowest transfer price that would not reduce operating income, we need to calculate the contribution margin per unit and subtract the opportunity cost of selling to outside customers.

Contribution margin per unit = selling price - variable cost = $2.40 - $1.60 = $0.80

Opportunity cost per unit = contribution margin per unit lost from outside sales = $0.80 x 15,000 units = $12,000

To avoid reducing operating income, the Lamp Division must pay at least enough to cover the variable cost plus the opportunity cost:

Transfer price = variable cost + opportunity cost = $1.60 + $12,000/25,000 units = $1.60 + $0.48 = $2.08

So, any transfer price less than $2.08 would reduce operating income. The only choice that satisfies this condition is C, which is $1.41.