Merlin Component's Hillside Division is currently operating at 100 percent capacity (capacity is 100,000 units). The normal selling price for its wrap film is $12 per case. At current operating levels, fixed costs are $3 per case and variable costs are $7 per case. Another division of Merlin Components would like to buy from the Hillside Division. If this sale is made, $1.20 per case in variable selling and administrative costs can be saved. Calculate the most acceptable transfer price per unit.

Question

Quizplus · Accepted Answer

Since the Hillside Division is operating at full capacity, any additional sales to the other division would require a reduction in sales to external customers. Therefore, the opportunity cost of each unit sold to the other division is the contribution margin foregone on a unit sold externally, which is $5 ($12 selling price - $7 variable cost).

If the sale is made to the other division, the Hillside Division will save $1.20 in variable selling and administrative costs. Therefore, the minimum acceptable transfer price would be:

Variable cost per unit + Opportunity cost per unit - Variable selling and administrative costs per unit
$7 + $5 - $1.20 = $10.80

Therefore, the most acceptable transfer price per unit is $10.80.

Merlin Component's Hillside Division Is Currently Operating at 100 Percent