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Jb Ltd is a divisionalised organisation comprising a number of divisions, including divisions A and B. Division A makes a single product, which it sells on the externa market at a price of 12 per unit. The variable cost of the product is 8 per unit and the fixed cost is 3 per unit. Market demand for the product considerably exceeds division A’s maximum production capacity of 10000 units per month.
Division B would like to obtain 500 units of the product from division A. If division A does transfer some of its production internally rather than sell externally, then the saving in packaging costs would be 1.5 per unit.
What transfer price per unit should division A quote in order to maximise group profit?
I thought the transfer price would be the marginal cost plus lost contribution from not being able to sell externally. So it should be 8 + (12-8+1.5) which is 13.5 but this is incorrect and I don’t understand why.
Also why the saving in packaging costs is added to the external market price of 12 in arriving at the answerIf the sell externally, then the marginal cost is the cost of producing ($8) plus the cost of packing (($1.50), so a total of $9.50. Therefore the lost contribution through not selling externally is 12 = 9.50 = $2.50.
Therefore the minimum transfer price is 8 + 2.50 = $10.50.
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