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Transfer Pricing: Minimum and Maximum

Division A of Hoover Inc. transfers its product to Division B. Division B can either buy the item internally or externally (cost = $75 each). Division A has just completed its annual cost update as follows:

Direct material $25.00
Direct labor 18.75
Variable manufacturing overhead 6.25
Fixed manufacturing overhead 5.00
Variable selling expenses 3.75
Fixed selling and administrative expenses 7.50

Total costs $66.25
Desired return 13.75
Sales price $80.00

Division A is operating at 80 percent of its 500,000 unit capacity.

1.) What is the minimum transfer price Division A should charge for internal transfers?
2.) What is the maximum price Division B would be willing to pay?
3.) Why should Division A reduce its price to Division B?

Solution Preview

The cost of producing the product consists of two components: variable costs (dependent on the level of production) and fixed costs (independent on the level of production).

The variable cost per unit is $25.00 (direct material) + $18.75 (direct labor) + $6.25 (variable manufacturing overhead) + $3.75 (variable selling expenses) = $53.75
The fixed cost per unit is ...

Solution Summary

This solution analyzes transfer pricing and the minimum transfer price the producing division is willing to charge and the maximum transfer price the receiving division is willing to pay.