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rotech group (6/14)
For part b) of this question, the minimum transfer price for 5340000 should be the marginal cost plus lost contribution. So is should be the marginal cost of 5340000*0.4 which is 2136000 plus lost contribution of 5340000. So it should be 7476000 but this is incorrect. I don’t understand why
It is not correct because there is a limit on how many they can sell externally (because the demand externally is limited) and so the lost contribution only applies to those they will sell externally.
The are currently satisfying 60% of the external demand and so they could sell an extra 40/60 x 8,010 = 5,340 externally. The marginal cost of these is 40% x 5,340 = 2,136, so the lost contribution if these are sold to W instead is 5,340 – 2,136 = 3,204. Therefore the minimum transfer price for these is 2,136 + 3,204 = 5,340 (which is obviously the external selling price anyway).
Currently they are selling 7,550 to W, all at the same price as the external sales. So although 5,340 of the sales will continue to be at full price (as in the previous paragraph) the remaining 2,210 (7,550 – 5,340) could be transferred at the marginal cost (because they cannot be sold externally as there is not the demand, and therefore there is no lost contribution. They could be transferred at the marginal cost of 40% x 2210 = 884.
So the total minimum charge by C is 5,340 + 884 = 6,224