Bradford Manufacturing Ltd. manufactures custom metal perforating and fabricating. Its Fabricating Division can transfer the perforated metal components to Bradford's Automotive Division or it can sell its products on the external market. Fabricating currently produces and sells 350,000 units per year to the external market at an average price of $38 per unit. Variable costs of production average $22.50 and fixed costs of $6.50/unit. Fabricating incurs $2.50 of variable selling costs on external sales. Fixed costs are based on the practical capacity of the plant which is 400,000 per year. The Automotive Division is interested in acquiring up to 50,000 units per year.
Required:
a. From the standpoint of Bradford Manufacturing Ltd., should the units be transferred? Determine the financial benefit or cost of your recommendation.
b. Using the general guidelines for transfer pricing, what is the minimum transfer price Fabricating should accept?
c. What is the range of acceptable transfer prices?
d. Now assume that demand in the external market for the components is expected to increase by 8%. The Automotive Division has negotiated with an external supplier to supply 50,000 units at a price of $34.50/unit. However, if the Automotive Division reduces its volume below the 50,000 unit volume, it must pay $39 per unit. What is the optimum sourcing arrangement for the company?

Question

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The Answer of Bradford Manufacturing Ltd. manufactures custom metal perforating and fabricating. Its Fabricating Division can transfer the perforated metal components to Bradford's Automotive Division or it can sell its products on the external market. Fabricating currently produces and sells 350,000 units per year to the external market at an average price of $38 per unit. Variable costs of production average $22.50 and fixed costs of $6.50/unit. Fabricating incurs $2.50 of variable selling costs on external sales. Fixed costs are based on the practical capacity of the plant which is 400,000 per year. The Automotive Division is interested in acquiring up to 50,000 units per year.
Required:
a. From the standpoint of Bradford Manufacturing Ltd., should the units be transferred? Determine the financial benefit or cost of your recommendation.
b. Using the general guidelines for transfer pricing, what is the minimum transfer price Fabricating should accept?
c. What is the range of acceptable transfer prices?
d. Now assume that demand in the external market for the components is expected to increase by 8%. The Automotive Division has negotiated with an external supplier to supply 50,000 units at a price of $34.50/unit. However, if the Automotive Division reduces its volume below the 50,000 unit volume, it must pay $39 per unit. What is the optimum sourcing arrangement for the company?