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.
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Hi Mr John,
from a mock exam
A company is capable of making two products X and Y
They can sell both products externally as follows
X Y
External price 80 100Variable Cost 60 70
contribution per unit 20 30
labour hrs per unit 5 10The company has limited labour hours available ,and another division requires product y.
What is the minimum transfer price that should be charged by the division in order to achieve goal congruence ?
How they got $ 110.00
Thanks,
$110 is quite correct!
You obviously have not watched the free lectures on transfer price because I work through (and explain) this precise example!!!
The minimum transfer price is the marginal cost plus any lost contribution.
Given that the labour hours are limited, selling X externally would generate $4 per hour, whereas selling Y externally would generate $3 per hour. Therefore if they were selling externally, they would choose to use all the hours available producing X, and be earning $4 per hour.
If they produce Y for the other division, then the marginal cost is $70, and the lost contribution is 10 hours at $4 per hour = $40. So the minimum transfer prise is 70 + 40 = $110 per unit.
I hope that makes sense, but if not then you really should watch the free lectures 🙂
Thank
But why for minimum price of y you have chosen $ 4.00 not 3.00 per hour ,if we say that Y generate a contribution $ 3.00 per hour,
Thanks,
Because if we were not supplying the other division then we would be selling X externally and getting $4.00 per hour. If we decide to produce Y for the other division then we will be losing $4.00 for every hour that we take away from production of X.
I really do suggest that you watch the lecture where I go through, and explain this.
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