Max Ltd.produces kitchen tools,and operates several divisions as investment centers.Division M produces a product that it sells to other companies for $16 per unit.It is currently operating at its full capacity of 45,000 units per year.Variable manufacturing cost is $9 per unit,and variable marketing cost is $3 per unit.The company wishes to create a new division,Division N,to produce an innovative new tool that requires the use of Division B's product (or one very similar).Division N will produce 30,000 units.Currently,Division N can purchase a product equivalent to Division M's from Company X for $15 per unit.However,Max Ltd.is considering transferring the necessary product from Division M.
Required:
1.Assume the transfer price is $12 per unit.How would this affect the purchasing costs of Division N? How would this affect the profits of Division M? How would this affect Max Ltd.as a whole?
2.What if the transfer price was $13 per unit?

Question

Quizplus · Accepted Answer

Feedback: 1.Division N needs 30,000 units.Outsourced,this would cost $450,000 ($15 x 30,000).Purchased from Division M,this would cost $360,000 ($12 x 30,000).Transferring would save $90,000.Division M is operating at capacity.It currently earns contribution of $4 per unit ($16 - $9 - $3)sold to outside customers.This means it makes $180,000 ($4 x 45,000)per year.If 30,000 units are transferred to Division N,then Division M would only have a margin of $3 per unit,and lose $30,000 per year.As a whole,the company would save $60,000 ($90,000 - $30,000)if transfer pricing @ $12 per unit was used.
2.Purchased from Division M,this would cost $390,000.Transferring would still save Division N $60,000.At $13,the new transfer profit margin would be $4 per unit.This is the same as the profit margin for selling to outside customers,so Division M would be indifferent about selling to outside customers versus transferring to Division N.As a whole,transfer pricing @ $13 per unit would save Max Ltd.$60,000.

Max LtdProduces Kitchen Tools,and Operates Several Divisions as Investment Centers