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Hello Tutor Hope you are doing well..
I have doubt in one of the question in the study text of Kaplan.
For convience I’m breaking the questions into different partsScenario –
“Frankie co has two divisions, A and B. Division A makes a component at a marginal cost of $30, which it can only sell to Division B.Division A has no other outlet for sales. Division B takes A’s component and turns it into a finished good, incurring its own cost of $55 per unit and selling it externally at $120”
Doubt No. 1)
Division A has decided it wants to maximise its own profits by selling externally at a price of $45 to Customer Co, after incurring distribution costs on external sales of $3 per unit. As before, Division A can also sell internally to Division B.
There’s a statement.
“If working at full capacity, $42 is the lowest transfer price Division A will accept”.
Here i wanted to ask shouldn’t this statement be false. With the minimum transfer Price being $39. ($42-$3), because $3 is the distribution cost on external sales and in case we sell it to Division B it should be an internal transaction and therefore, no distribution Cost.
Doubt No. 2)
Division A operates at full capacity and sells all its components for $45 to Customer Co, after incurring distribution costs on external sales of $3 per unit.
Third Co, the original external supplier to Division B, has now gone out of business but Fourth Co, another external supplier, has offered to supply Division B for $29 per unit.
What should Frankie Co do to maximise company profitability?
a) Division A should not produce the component for Division B and keep all its units for external sales.
b) Division A should redirect some of its external sales towards Division B and sell to Division B at price between $30 and
$40.c) Division A should not produce at all and all supplies should be externally sourced from Fourth Co.
d) Division A should try and sell all its components to Division B for $42.
I chose option A. Because there was a similar requirement like this, in which statement A was correct.
But as per the study text the correct answer is C and i couldn’t understood the reason provided for option c being right.
Can they please help me out Tutor.
The “minimum” a selling division would accept is VC or MC plus any lost contribution
So the lowest Div A would accept is 30 the cost of making its component.The buying division would want a price that will leave them worse off so the most they will pay is: They can sell it for 120 – it costs 55 to process it
So the most they willing to pay is 65 that is the net marginal rev = (SP – Additional VC)
The “maximum” price
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