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	89,000	409,000	159,000	309,000
Number of units now being sold to outside customers	89,000	409,000	109,000	309,000
Selling price per unit to outside customers	$ 48	$ 108	$ 120	$ 68
Variable costs per unit	$ 36	$ 83	$ 85	$ 44
Fixed costs per unit (based on capacity)	$ 6	$ 15	$ 20	$ 9
Beta Division:
Number of units needed annually	14,000	39,000	29,000	121,800
Purchase price now being paid to an outside supplier	$ 45	$ 107	$ 120*

*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 309,000 units to Beta Division for $106 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 29,000 units from Alpha Division at $105 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 121,800 units of a different product from the one Alpha Division is producing now. The new product would require $39 per unit in variable costs and would require that Alpha Division cut back production of its present product by 45,675 units annually. What is Alpha Divisions lowest acceptable transfer price?