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Hi John, this question is from Mock exam 3 from the BPP kit – question No 5 on transfer pricing. How and why is the answer $750. I know the Minimum TP when in full capacity should be opportunity cost plus variable cost. I didn’t understand the part where Y takes 4 hours and X takes 6 hours. Please can you explain. Thanks very much
At the moment B is making product Y. Each unit of Y takes 4 hours and therefore they are currently earning a contribution of (600 – 200 – 80) / 4 = $80 per hour.
If they make product X the they will have the marginal cost of 150 + 120 = 270 per unit. Each unit of product X takes 6 hours and every hour used is taking hours away from production of Y and therefore thy lose contribution of 6 hours x $80 per hour = 480
So the minimum transfer price is 270 + 480 = $750.
This is very similar to the last example that I work through in my free lectures on transfer pricing.