The Alpha Division of the Carlson Company manufactures product X at a variable c
ID: 2345077 • Letter: T
Question
The Alpha Division of the Carlson Company manufactures product X at a variable cost of $40 per unit. Alpha Division's fixed costs, which are sunk, are $20 per unit. The market price of X is $70 per unit. Beta Division of Carlson Company uses product X to make Y. The variable costs to convert X to Y are $20 per unit and the fixed costs, which are sunk, are $10 per unit. The product Y sells for $80 per unit.Required:
a. What transfer price of X causes divisional managers to make decentralized decisions that maximize Carlson Company's profit if each division is treated as a profit center?
b. Given the transfer price from part (a), what should the manager of the Beta
Division do?
c. Suppose there is no market price for product X. What transfer price should be
used for decentralized decision-making?
d. If there is no market for product X, is the operations of the Beta Division
profitable?
Explanation / Answer
a)The general rule of transfer pricing is to use the external market price of the intermediate product of service if a competitive market exists.” (text book, pp. 213) Since a market price exists, the transfer price of X should be the market price of X which is $70 per unit. b)Since the transfer price is $70 (which is the opportunity cost for product X), adding the product conversion (X to Y) variable cost of $20 and fixed cost of $10 will result in a product cost (Y) of $100. This is greater than the product Y’s selling price of $80, and thus will result in a loss for Beta Division. Hence Beta Division’s manager should look at closing the division and look for a more profitable opportunity. c)Opportunity costs are approximated by the variable cost if the fixed costs are sunk.” Hence, if no market price existed for product X then variable cost of $40 per unit should be used as the transfer price (since the Alpha’s fixed costs are sunk). d)If there is no market for product X, then the variable cost of $40 per unit gets treated as the transfer price. Hence, the operation of Beta Division is profitable. Product cost = $40 + $20 + $10 = $70 Selling price = $80 Profit = $10 per unit
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