Refer to Problem 23-28.
In Problem 23-28
Europa, Inc., has two divisions, A and B, which 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 centre. The transfer price for the subassembly has been set at the long-run average market price. The following data are available for each division:
Selling price for final product………….. $300
Long-run average selling price for intermediate product… 200
Incremental cost per unit for completion in Division B…. 150
Incremental cost per unit in Division A……….. 120
The manager of Division B has made the following calculation:
1. Suppose the manager of Division A has the option of (a) cutting the external price to $195, with the certainty that sales will rise to 1,000 units or (b) maintaining the external price of $200 for the 800 units and transferring the 200 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?
2. Suppose that if the selling price for the intermediate product were dropped to $195, sales to external parties could be increased to 900 units. Division B wants to acquire as many as 200 units if the transfer price is acceptable. For simplicity, assume that there is no external market for the final 100 units of Division A’s capacity.
a. Using the general guideline, what is (are) the minimum transfer price(s) that should lead to the correct economic decision? Ignore performance-evaluation considerations.
b. Compare the total contributions under the alternatives to show why the transfer price(s) recommended lead(s) to the optimal economic decision.