Milner Technologies is a large, multidivision firm. One division, Testing, is well known inside Milner for its efficient information technology (IT). A smaller division, Energy, has approached Testing with a proposal that Testing provide IT support in the form of machine time for some of Energy’s administrative work.

After an analysis of the demands that Energy would place on the system, the IT manager of Testing notes that Testing would have to lease a new server because of the additional load. The lease rates for the current server are a fixed annual lease of $2,600, and it averages machine time of 4,200 hours annually. The new server leases for an annual rate of $4,000. Because the new server is a faster machine, Testing can complete its current requirements in only 3,000 hours. The work for Energy is estimated to be 1,500 hours.

In addition to leasing a new server, there are two other changes Testing would have to make in IT. First, it will have to upgrade its server support position. The IT manager estimates that it will cost an additional $16,000 per year to get an individual with the necessary advanced training. In addition, Testing has a contract for service from the machine vendor. The support contract is a fixed-price contract of $2 per hour of machine usage. The current lease contract can be canceled at no cost if Testing leases a more expensive machine.

Required

a. Assume that no outside market exists for this service and that Testing would have excess capacity on the new server. What is the optimal transfer price rule Testing should use to charge Energy?

b. Suppose Energy uses 1,500 hours on the new machine. What is the average cost per hour Energy would pay using the rule you developed in requirement (a)?

c. Suppose Energy uses 150 hours on the new machine. What is the average cost per hour Energy would pay using the rule you developed in requirement (a)?