Please note in respect of Mercury Corporation: a) Mercury already operating at F

Question

Please note in respect of Mercury Corporation:

a) Mercury already operating at FULL capacity. Therefore minimum transfer price depends on external selling price and cost saving on internal sales.

b) you are expected to calculate net loss in contribution margin which is sum of contribution margin lost by Mercury and increased CM by vehicle division.

2. Mercury Corporation manufactures car audio systems. It is a division of Country-Wide Motors, which manufactures vehicles. Mercury sells car audio systems to other divisions of Country-Wide, as well as to other vehicle manufacturers and retail stores. The following information is available for Mercury's standard unit: variable cost per unit $31, fixed cost per unit $23, and selling price to outside customer $85. Country-Wide currently purchases a standard unit from an outside supplier for $80. Because of quality concerns and to ensure a reliable supply, the top management of Country-Wide has ordered Mercury to provide 200,000 units per year at a transfer price of $30 per unit. Mercury is already operat- ing at full capacity. Mercury can avoid $2 per unit of variable selling costs by selling the unit internally. Determine minimum transfer price. (Lo 4) Instructions (a) What is the minimum transfer price that Mercury should accept? (b) What is the potential loss to the corporation as a whole resulting from this forced transfer? (c) How should the company resolve this situation?

Explanation / Answer

(a) Minimum Transfer Price that Mercury should accept would depends on external selling price and cost saving on internal sales i.e. $85 - 2 = $83.

(b) In case Mercury transfers 200000 units per year at $30 per unit internally, it is going to lose its external contribution is respect of 200000 units.

Contribution lost = 85 - 31 = $54 per unit * 200000 = $10,800,000.

Contribution recovered = 30 - (31 - 2) = $1 per unit * 200000 = $200000

Thus potential loss = $10,800,000 - $200,000 = 10,600,000

(c) Company should resolve this problem by increasing its transfer price to Minimum transfer price which would be equal to Contribution lost from external sales + variable costs incurred in internal transfers.

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