Appropriate Transfer Prices: Opportunity Costs J. Carter Peanut Butter Company r

Question

Appropriate Transfer Prices: Opportunity Costs

J. Carter Peanut Butter Company recently acquired a peanut-processing company that has a normal annual capacity of 4,000,000 pounds and that sold 2,800,000 pounds last year at a price of $3.50 per pound. The purpose of the acquisition is to furnish peanuts for the peanut butter plant, which needs 1,600,000 pounds of peanuts per year. It has been purchasing peanuts from suppliers at the market price.

Production costs per pound of the peanut-processing company are as follows:

Management is trying to decide what transfer price to use for sales from the newly acquired Peanut Division to the Peanut Butter Division. The manager of the Peanut Division argues that $3.50, the market price, is appropriate. The manager of the Peanut Butter Division argues that the cost price of $1.94 (or perhaps even less) should be used since fixed overhead costs should be recomputed. Any output of the Peanut Division up to 2,800,000 pounds that is not sold to the Peanut Butter Division could be sold to regular customers at $3.50 per pound.

(a) Compute the annual gross profit for the Peanut Division using a transfer price of $3.50.
$Answer

(b) Compute the annual gross profit for the Peanut Division using a transfer price of $1.94.
$Answer

(c) Which of the following is least likely to motivate the manager of the Peanut Butter Division to act in a manner that will maximize corporate profits?

$3.50 transfer price set for all transfers.

$1.64 transfer price set for all transfers.

$1.64 transfer price set for the first 300,000 lbs.

$1.64 transfer price set for the first 300,000 lbs. and $3.50 for the next 400,000 lbs.

None of the above.

Direct materials $ 0.90 Direct labor 0.52 Variable overhead 0.22 Fixed overhead at normal capacity 0.30 Total $ 1.94

Explanation / Answer

Solution 1 Unit cost Units Total Selling price           3.50          4,000,000    14,000,000 Direct Material           0.90          4,000,000      3,600,000 Direct labor           0.52          4,000,000      2,080,000 Variable overhead           0.22          4,000,000          880,000 Fixed overhead           0.30          4,000,000      1,200,000 Total Cost      7,760,000 Gross Profit      6,240,000 Solution 2 Unit cost Units Total Selling price           3.50          2,400,000      8,400,000           1.94          1,600,000      3,104,000 Toal    11,504,000 Direct Material           0.90          4,000,000      3,600,000 Direct labor           0.52          4,000,000      2,080,000 Variable overhead           0.22          4,000,000          880,000 Fixed overhead           0.30          4,000,000      1,200,000 Total Cost      7,760,000 Gross Profit      3,744,000 We are assuming the primary purpose of acquisition was to procure the peanut to peanut butter division and hence first the requirement of butter division will be fullfilled rest will be sold in open market Solution C Option a is correct. Since transfer price set is same as market price, butter division manager will not be interested but having purchased even at market price from peanut processing unit, the profit on additional units will accrue to the corporate level

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