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Calculating Transfer Price

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A firm has two semi-autonomous divisions: production and marketing. The production division manufactures a product that is purchased and then resold by the marketing division. The marginal cost functions for the production division and for the value added by the marketing division are defined below.

MCP = 2Q MCM = Q

The demand function for the product is:
QD = 100 - P

a) Assume that there is no external market for the output of the production division. How many units should be produced and what transfer price should be paid to the production division by the marketing division?

b) Assume that the external market for the output of the production division is perfectly competitive and that the market price is $52. How many units should be produced by the production division, how many should be purchased by the marketing division, what transfer price should be paid to the production division by the marketing division, and what price should be charged for the product by the marketing division?

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a. Assume that there is no external market for the output of the production division. How many units should be produced and what transfer price should be paid to the production division by the marketing division?

In case of absence of external market, Transfer price=Marginal Cost of production division=2Q

Total marginal cost of marketing division=MCT=Transfer price+ marginal cost of value addition
MCT=2Q+MCM=2Q+Q=3Q

QD=100-P
On rearranging, we get
P=100-QD
Total Revenue=TRM=P*QD=(100-QD)*QD=100QD-QD^2
Marginal Revenue=MR=dTRM/dQD=100-2QD

If output of marketing division is Q, ...

Solution Summary

Solution determines the transfer prices in case of with and without presence of external market.

$2.19
See Also This Related BrainMass Solution

Cost Accounting for Meredith Motor Works: Calculate transfer prices

See attached file for proper format.

3 Meredith Motor Works has just acquired a new Battery Division. The Battery Division produces a standard 12volt battery that it sells to retail outlets at a competitive price of $20. The retail outlets purchase about 600,000 batteries a year. Since the Battery Division has a capacity of 1,000,000 batteries a year, top management is thinking that it might be wise for the company's Automotive Division to start purchasing batteries from the newly acquired Battery Division.
The Automotive Division now purchases 300,000 batteries a year from an outside supplier, at a price of $18 per battery. The discount from the competitive $20 price is a result of the large quantity purchased.

The Battery Division's cost per battery is shown below:
Direct materials 8
Direct labor 4
Variable overhead 2
Fixed overhead 2
Total cost 16

*Based on 1,000,000 batteries.

Both divisions are to be treated as investment centers, and their performance is to be evaluated by the ROI formula.

Required:
a What transfer price would you recommend and why?
b What transfer price would you recommend if the Battery Division is now selling 1,000,000 batteries a year to retail outlets?
c Refer to (A). Top Management has decided the transfers between the two divisions should be at $19. Compute the effect of the transfer on the net income for the Battery Division, Automotive Division, and the total company.

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