Problem 11A-6 Basic Transfer Pricing [LO11-5) Alpha and Beta are divisions withi
ID: 2432501 • Letter: P
Question
Problem 11A-6 Basic Transfer Pricing [LO11-5) Alpha and Beta are divisions within the same company. The managers of both divisions are evaluated based on their own division's return on investment (ROI). Assume the following information relative to the two divisions Alpha Division: 57,000 281,000 101,000 200,000 Number of units now being sold to outside customers 57,000 281,000 76,000 200,000 Selling price per unit to outside 66 $ customers Variable costs per unit Fixed costs per unit (based on 48 32 $60 $ 22 $ capacity) $20 14 22 Beta Division: Number of units needed annually10,700 67,000 20,000 64,000 Purchase price now being paid to an outside supplier s 90 43 66. Before any purchase discount. Managers are free to decide if they will participate in any internal transfers. All transfer prices are negotiated. Required 1. Refer to case 1 shown above. Alpha Division can avoid $4 per unit in commissions on any sales to Beta Division. a. What is the lowest acceptable transfer price from the perspective of the Alpha Division? b. What is the highest acceptable transfer price from the perspective of the Beta Division? c. What is the range of acceptable transfer prices (if any) between the two divisions? Will the managers probably agree to a transfer? 2. Refer to case 2 shown above. A study indicates that Alpha Division can avoid $5 per unit in shipping costs on any sales to Beta Division.Explanation / Answer
1. a. Lowest acceptable transfer price from the perspective of Alpha Division ( Selling Division) = Variable cost per unit + Contribution lost on regular orders = $ ( 60 - 4) + $ ( 97 - 60) = $ 93.
b. Highest acceptable transfer price from the perspective of Beta ( Buying) Division = $ 90
c. As the lowest transfer price for Alpha is $ 93, and the highest is $ 90 that Beta would be willing to pay, there is no range of acceptable transfer prices between the two divisions.
No, the managers would not agree to a transfer.
2. a. Lowest transfer price from the perspective of Alpha = $ ( 22 - 5) + $ ( 44 - 22) = $ 39
b. Highest acceptable transfer price from the perspective of Beta = $ 43.
c. The range of acceptable transfer price between the two divisions: $ 39 > TP < $ 43.
Yes, disagreement is possible. Alpha would be bargaining for $ 43 ( as that is the price currently being paid by Beta) and Beta would insist on $ 39, as that is an accetable transfer price for Alpha.
d. Potential loss for the company as a whole:$ 201,000.
Additional contribution margin lost = 67,000 x [ $ ( 44 - 22) - $ ( 42 - 17)] = $ 201,000.
3. a. Lowest acceptable transfer price for Alpha = $ 42.
b. Highest acceptable transfer price for Beta = $ 66 x ( 1 - 0.04) = $ 63.36.
c. Range of acceptable transfer prices: $ 42 > TP < $ 63.36
The managers would probably finally agree, but after a lot of haggling.
d. ROI will increase, as $ 58.36 per unit transfer price leaves a positive contribution margin of $ ( 58.36 - 42) = $ 16.36.
Total contribution margine increase for Alpha = $ 16.36 x 20,000 = $ 327,200. This, plus the fact that there will be utilization of spare capacity for Alpha, a higher recovery of fixed costs would lead to a higher ROI.