Comments

  1. avatar says

    Hi John, thanks for your detailed reply. But I still agree with Damien.

    Can you correct me if I am wrong here:
    I agree with you that “If Division B did not exist, then Division A would use all their labour producing product X and would earn $4 per hour (20/5).”
    But for argument sake, had Division A only used all their labour producing product Y and it would have earned $3/h any way.
    So the actual loss in making Y instead of X is only $1/h, the net lost contribution.
    Namely, Division A only needs to be compensated by $1/hour, not $4/hour. As the other $3/h would have been compensated by selling product Y.
    Then the minimum cost would be 80, as Damien said.

    Looking forward to hearing from you.

    Thanks John.

    • avatar says

      @custardonut,
      Hi if I understand John correctly, we should not be even selling product Y. And should we sell product Y, we would need to sell it at $4/hr to make sense selling it. Thus from this the contribution lost would still be $4/hr. Please do correct me John if I had mistake your meaning. Cheers

    • avatar says

      Dear Sir / Madam,

      This seems logical. As by producing Y we lose only 1 USD per hour ( For not producing X) as Minimum Transfer Price should be 70 ( Marginal Cost) + Lost Contribution by not producing X is 10 USD ( 10 HOURS X 1 USD) Thus it would be 80 USD .

      Would it be acceptable ! Kindly guide.

  2. Avatar of John Moffat says

    If Division B did not exist, then Division A would use all their labour producing product X and would earn $4 per hour (20/5).

    They would only be happy to produce Product Y (for anybody!) if it gave them at least $4 per hour. (That is why at the moment they are not producing Product Y – it only gives $3 per hour and so they don’t produce it).

    So…..for Y to be generating $4 per hour it would need to be sold for $110 (70 + (10*4)).

    To sell at any price lower than this would make no sense at all because the contribution per hour would be less than they would make by selling product X.

  3. avatar says

    should the opportunity cost not be only 10 since the net lost contribution would only be 4-3=1 per hour (the difference between the contribution of the two units per hour) and therefore the minimum cost would be 70 +10=80

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