Chicago, Inc., has two divisions, A and B, that manufacture expensive bicycles. Division A produces the bicycle frame, and division B assembles the rest of the bicycle onto the frame. There is a market for both the subassembly and the final product. Each division has been designated as a profit center. The transfer price for the subassembly has been set at the long-run average market price. The following data are available for each division:

The manager of division B has made the following calculation:

Required

1. Should transfers be made to division B if there is no unused capacity in division A? Is the market price the correct transfer price? Show your computations.
2. Assume that division A’s maximum capacity for this product is 1,200 units per month and sales to the intermediate market are now 900 units. Assume that for a variety of reasons, division A will maintain the $275 selling price indefinitely. That is, division A is not considering lowering the price to outsiders even if idle capacity exists. Should 300 units be transferred to division B? At what transfer price?

3. Suppose division A quoted a transfer price of $240 for up to 300 units. What would be the contribution to the company as a whole if a transfer were made? As manager of division B, would you be inclined to buy at $240? Explain.
4. Suppose the manager of division A has the option of 

(a) Cutting the external price to $270, with the certainty that sales will rise to 1,200 units.

(b) Maintaining the external price of $275 for the 900 units and transferring the 300 units to division B at a price that would produce the same operating income for division A. What transfer price would produce the same operating income for division A? Is that price consistent with that recommended by the general guideline in the chapter so that the resulting decision would be desirable for the company as a whole?

Transcribed Image Text:

Selling price for final product Long-run average selling price for intermediate product Incremental cost per unit for completion in division B Incremental cost per unit in division A $360 275 120 150