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Hi sir,
In this question I have doubt in part b and c where in part a they calculate contribution division A (15-3-4-1) and incremental cost for division b (13-7) why and how I know to do like this? And in part c I m not able to understand. So can you please explain me. Thanks in advance
Part b is following the normal rules for ‘sensible’ transfer pricing.
A can either sell adaptors to B or sell them externally.
If they sell externally then they make a contribution of 15 – 3 – 4 – 1 = $7 per unit.
It is only worth them selling to B instead provided they charge more than the marginal cost of $7 plus the lost contribution of $7, which means they need to charge B at least $14.However B can buy externally for $13 and so will prefer to buy externally.
So A will sell as many as they can externally, which is 200,000.A is capable of producing an additional 150,000 which they can not sell externally (and will therefore not result in lost contribution) and so they can sell these to A at anything in excess of the marginal cost of $7. (So B will buy 150,000 from A).
In Part (c), if B wants 180,000 from A (because there is now no external supplier) then the extra 30,000 would mean losing external sales and so they would have to charge at least $14 per unit for these 30,000.
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