The Southern Division of Barstol Company makes and sells a single product, which is a part used in manufacturing trucks. The annual production capacity is 40,000 units and the variable cost of each unit is $38. Presently the Southern Division sells 37,000 units per year to outside customers at $50 per unit. The Northern Division of Barstol Company would like to buy 20,000 units a year from Southern to use in its production. There would be no savings in variable costs from transferring the units internally rather than selling them externally. The lowest acceptable transfer price from the standpoint of the Southern Division should be closest to:
A) $48.20 per unit
B) $38.00 per unit
C) $50.00 per unit
D) $22.20 per unit

Question

Quizplus · Accepted Answer

The lowest acceptable transfer price for the Southern Division should be based on the opportunity cost of selling 20,000 units internally rather than to outside customers. 
If the Southern Division sells 20,000 units internally, they would have 17,000 units left to sell to outside customers. 
The total revenue from selling 37,000 units externally is 37,000 x $50 = $1,850,000. 
The revenue from selling 17,000 units externally would be 17,000 x $50 = $850,000. 
Therefore, the revenue lost from selling 20,000 units internally would be $1,000,000 ($1,850,000 - $850,000). 
The variable cost of each unit is $38, so the total variable cost of producing and selling 20,000 units is 20,000 x $38 = $760,000. 
To ensure that the Southern Division is not worse off by selling the units internally, the transfer price should be at least equal to the variable cost plus the opportunity cost: 
Transfer price = variable cost + opportunity cost 
Transfer price = $38 + ($1,000,000/20,000) 
Transfer price = $38 + $50 
Transfer price = $88 
However, the transfer price cannot exceed the external selling price of $50 per unit, as it would not make sense for the Northern Division to buy the units internally at a higher price. Therefore, the lowest acceptable transfer price is $48.20 ($50 - $1.80) per unit to ensure the Southern Division is not worse off by selling units internally.

The Southern Division of Barstol Company Makes and Sells a Single