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I have the followin problem:
Division A – budgeted information for the coming year:
Max capacity – 150,000 bits
External sales – 1100,000 bits
External selling price – 35 $ / unit
VC – 22 $ / unit
FC – 1,080,000 $
Capital employed – 3,200,000 $
Target RI – 180,000 $
Cost of capital – 12 % / yearDivision C has found another 2 companies willing to supply bits. X could supplys for 28 $ / bit, only for annual orders in excess of 50,000 bits. Z could supply any quantity at 33 $ / bit.
What is the transfer price per bit that Division A shold quote, in order to meet its residual income target.
I don’t know hot to link the Residual Income target to transfer price / bit.
Please help me understand.
Thank you
The residual income target enables you to calculate the profit required in order to meet the target.
Then you can calculate the transfer price needed to be able to get that profit.I calculated the notional interest on capital and I added residual income and fixed cost and obtained 1,644,000 $. I divided by 150,000 (bits) and obtained 10,96 / bit. 10,96 $ / bit + 22 $ / bit VC = 30,96 $ / unit.
But, the solution says that the TP / unit is 27.9 $. In the amount of 1,644,000 profit required, it is taken into consideration 90,000 bits at 13 $ contribution / unit and the rest of amount is divided to 60,000 units, so the result is 7.9 $ / unit. This 7.9 $ / unit is added to 22 $ VC / unit.I don’t understand exactly why is taken into consideration, for the 90,000 units only the contribution of 13 $ / unit. Is it ok to assume that the difference between the price of 35 $ / unit and 22 $ / unit of VC is the profit for one unit sold internally? Because it is mentioned that 35 $ / unit is the external selling price.
Sorry if I am not clearly enough,
Thank you
Are you sure that you have typed out the whole question, because there is no mention of how many bits Division C wants.
I am very sorry. I just forgot to write. Division C wants to buy 60,000 Bits from Division A.
If C wants 60,000 then A will supply 90,000 (150,000 – 60,000) externally and get a contribution of $13 a unit, so a total contribution of 1,170,000.
This means that the units sold to A have to generate 1,644,000 – 1,170,000 = 474,000 contribution, which is 474,000/60,000 = $7.90 per unit.
For the contribution to be 7.90, the transfer price must be 7.90 + 22 = $29.90
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