Ebbs Products, Incorporated, has a Motor Division that manufactures and sells a number of products, including a standard motor. Data concerning that motor appear below: The Automotive Division of Ebbs Products, Inc needs 9,000 special heavy-duty motors per year. The Motor Division's variable cost to manufacture and ship this special motor would be $46 per unit. Because these special motors require more manufacturing resources than the standard motor, the Motor Division would have to reduce its production and sales of standard motors to outside customers from 86,000 units per year to 72,500 units per year.From the standpoint of the Motor Division, what is the minimal acceptable transfer price for the special motors for the Automotive Division?
A) $84.00 per unit
B) $103.00 per unit
C) $81.00 per unit
D) $64.00 per unit

Question

Ebbs Products, Incorporated, has a Motor Division that manufactures and sells a number of products, including a standard motor. Data concerning that motor appear below:  The Automotive Division of Ebbs Products, Inc needs 9,000 special heavy-duty motors per year. The Motor Division's variable cost to manufacture and ship this special motor would be $46 per unit. Because these special motors require more manufacturing resources than the standard motor, the Motor Division would have to reduce its production and sales of standard motors to outside customers from 86,000 units per year to 72,500 units per year.From the standpoint of the Motor Division, what is the minimal acceptable transfer price for the special motors for the Automotive Division?
A) $84.00 per unit 
B) $103.00 per unit 
C) $81.00 per unit 
D) $64.00 per unit

Quizplus · Accepted Answer

To determine the minimal acceptable transfer price for the special motors, we need to consider the opportunity cost of selling 9,000 special motors instead of 13,500 standard motors (86,000 - 72,500). The contribution margin per unit of standard motor is $88 ($152 - $64), so by producing and selling 13,500 standard motors, the Motor Division can generate a contribution margin of $1,188,000 ($88 x 13,500). If the Motor Division sells 9,000 special motors to the Automotive Division, it would lose this contribution margin.

Therefore, the minimal acceptable transfer price for the special motors should be at least $46 (variable cost per unit of special motor) plus $132 ($1,188,000/9,000) to cover the opportunity cost, which equals $178 per unit. However, this price is higher than the market price of $152 for the standard motor, so the Automotive Division would not accept it.

Therefore, the Motor Division should set the transfer price at the market price of the standard motor minus the variable cost per unit of the special motor, which equals $103 ($152 - $46). This transfer price ensures that the Motor Division covers its variable cost and the opportunity cost of selling the special motors, while the Automotive Division gets a price that is lower than the market price for a comparable product.

Ebbs Products, Incorporated, Has a Motor Division That Manufactures and Sells