Please refer to page 75 example 8
I dont understand why the answer state “if no transfers to B then A would sell exactly and generate $4 per hour contribution.”
The question states that Division B requires product Y from Division A. So isnt they suppose to refer on Y contribution per hour and not X (S4 per hour contribution)?
Same goes to the 2nd point of answer which want to make transfers of Y worthwhile.
I understand that when there are external market and no spare capacity, in order to make the transfer worthwhile we have to use Marginal cost + opportunity cost).
However, i am a little confuse with the answer in pg 104. that stated 70+(10X4). Why is it using contribution per unit of X when the question is saying that divison B requires product Y from Division A?
In transfer pricing you assume that head office does not interfere and that each divisionwill do whatever maximises its own profit.
A could earn $4 per hour selling X outside and any other sale will have to be at least as good as that earning rate. To make a unit of Y will take 10 hours and that would sacrifice 4 x 10 = 40 contribution available had it made X. Therefore to compensate it for making Y the transfer price must be $70 + $40 = 110..
But Y is selling externally by earning $3 contribution per hour.
So, generally, i must consider about prioritize in maximize its own division(A) by charging another division(?
Means that I should use the highest contribution gained on any products (eg, X Y Z) produced by division A as my opportunity cost?
Am i right?
A will not transfer to B unless it is compensated for its lost contribution. We are notgoing to tell A what to do. We give it a transfer price and hope that it makes the correct decision for the group.
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