Electronic Division makes a part that sells externally for $50.00 per unit. It has a variable production cost of $22.00 per unit, a variable selling and administrative cost of $7.00 per unit, a fixed production cost of $1,000,000 per year, and a fixed selling and administrative cost of $500,000 per year. Production capacity is 250,000 units per year. Electronic Division is selling all it can produce externally at $50.00 per unit. One-half of the variable selling and administrative cost can be eliminated on units transferred to the Digital Division. Digital Division can buy the part externally at $48.00 per unit and uses 30,000 parts annually. Should a transfer take place, and if so what are the rational limits on the range of transfer prices?

Question

Quizplus · Accepted Answer

To determine if a transfer should take place, we need to compare the cost of selling externally versus the cost of a transfer.

For External Sales:
Revenue per unit = $50.00
Variable Cost per unit = $22.00 + $7.00 = $29.00
Contribution Margin per unit = $50.00 - $29.00 = $21.00

For Internal Transfer:
Digital Division is willing to pay up to $48.00 per unit externally.
Variable Cost per unit = $22.00 + ($7.00/2) = $25.50
Contribution Margin per unit transferred = $50.00 - $25.50 = $24.50

However, we also need to consider the fixed costs that are incurred regardless of whether the units are sold externally or transferred internally.

Total Fixed Costs = $1,000,000 + $500,000 = $1,500,000
Fixed Cost per unit = $1,500,000/250,000 = $6.00

For External Sales:
Contribution Margin per unit - Fixed Cost per unit = $21.00 - $6.00 = $15.00

For Internal Transfer:
Contribution Margin per unit transferred - Fixed Cost per unit = $24.50 - $6.00 = $18.50

Based on these calculations, it is beneficial to transfer internally as long as the transfer price is greater than the variable cost per unit plus the fixed cost per unit, which is $25.50 + $6.00 = $31.50.

Therefore, a transfer should take place between $46.50 and $48.00, which is the range where the Digital Division is willing to pay more than the sum of the variable and fixed costs.

The optimal transfer price may depend on other factors such as inventory holding costs, but based on the information given, the range of $46.50 to $48.00 is the rational limit for a transfer.

Electronic Division Makes a Part That Sells Externally for $50