Problem 11-25 (Algo) Basic Transfer Pricing [LO11-3]

Alpha and Beta are divisions within the same company. The managers of both divisions are evaluated based on their own divisions return on investment (ROI). Assume the following information relative to the two divisions:

	Case
	1	2	3	4
Alpha Division:
Capacity in units	93,000	413,000	163,000	313,000
Number of units now being sold to outside customers	93,000	413,000	113,000	313,000
Selling price per unit to outside customers	$ 56	$ 116	$ 140	$ 76
Variable costs per unit	$ 44	$ 91	$ 105	$ 52
Fixed costs per unit (based on capacity)	$ 6	$ 15	$ 20	$ 9
Beta Division:
Number of units needed annually	18,000	43,000	33,000	122,600
Purchase price now being paid to an outside supplier	$ 53	$ 115	$ 140*

*Before any purchase discount.

Required:

1. Refer to case 1 shown above. Alpha Division can avoid $2 per unit in commissions on any sales to Beta Division.

a. What is Alpha Division's lowest acceptable transfer price?

b. What is Beta Division's highest acceptable transfer price?

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.

a. What is Alpha Division's lowest acceptable transfer price?

b. What is Beta Division's highest acceptable transfer price?

c. What is the range of acceptable transfer prices (if any) between the two divisions? Would you expect any disagreement between the two divisional managers over what the exact transfer price should be?

d. Assume Alpha Division offers to sell 43,000 units to Beta Division for $114 per unit and that Beta Division refuses this price. What will be the loss in potential profits for the company as a whole?

3. Refer to case 3 shown above. Assume that Beta Division is now receiving an 8% price discount from the outside supplier.

a. What is Alpha Division's lowest acceptable transfer price?

b. What is Beta Division's highest acceptable transfer price?

c. What is the range of acceptable transfer prices (if any) between the two divisions? Will the managers probably agree to a transfer?

d. Assume Beta Division offers to purchase 33,000 units from Alpha Division at $125 per unit. If Alpha Division accepts this price, would you expect its ROI to increase, decrease, or remain unchanged?

4. Refer to case 4 shown above. Assume that Beta Division wants Alpha Division to provide it with 122,600 units of a different product from the one Alpha Division is producing now. The new product would require $47 per unit in variable costs and would require that Alpha Division cut back production of its present product by 45,975 units annually. What is Alpha Divisions lowest acceptable transfer price?