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Lowest acceptable transfer price

Ulrich Company has a Castings Division which does casting work of various types. The company's Machine Products Division has asked the Castings Division to provide it with 20,000 special castings each year on a continuing basis. The special casting would require $12 per unit in variable production costs.
In order to have time and space to produce the new casting, the Castings Division would have to cut back production of another casting - the RB4 which it presently is producing. The RB4 sells for $40 per unit, and requires $18 per unit in variable production costs. Boxing and shipping costs of the RB4 are $6 per unit. Boxing and shipping costs for the new special casting would be only $1 per unit, thereby saving the company $5 per unit in cost. The company is now producing and selling 100,000 units of the RB4 each year. Production and sales of this casting would drop by 25 percent if the new casting is produced. Some $240,000 in fixed production costs in the Castings Division are now being covered by the RB4 casting, 25 percent of these costs would have to be covered by the new casting if it is produced and sold to the Machine Products Division.
Required:

According to the formula in the text, what is the lowest acceptable transfer price from the viewpoint of the selling division? Show all computations.

Solution Preview

The calculation of transfer price is
Transfer price = Variable cost + contribution margin lost on outside sales
In this case, the variable costs for new casting are
Variable production cost $12
Boxing and shipping $1
Total variable cost = ...

Solution Summary

The solution explains how to calculate the lowest acceptable transfer price

$2.19