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– Division A sells product X to division B.
Division B process it ( variable processing cost $5 ) , sells ” processed X” to outside market at 25.
Maximum B would pay : Net marginal revenue = ( 25 – 5) = 20.
Question : how would answer be different if Division B has an offer to buy X ( unprocessed) for say $14 or say $18.
Only thing i know is how net marginal revenue is calculated but dont know whether it will be affected by this market offer?
(Costs are put to ask question easily, please put further values if required for better explanation)
If NMR = 20, B would be willing to buy in at either 14 or 18 as it could still make a positive contribution.
However, if Div A could make Product X for, say $10, it would be better for the group if B were to buy from A as $10 < 14 and <18.
So to encourage B to buy from A, the transfer price must be no greater than it could buy in from outside otherwise B would choose to buy at a lower price form outside.
Case 1:
if B had an intermediate market to buy for 21 and Division A selling for 22
NMR= 20
Division B would not buy it from either .Transfer Price should be maximum 20 i.e NMR .
Case 2:
Offer for 22 , Division A selling for 21NMR= 20
Division B would buy from outside. Transfer Price should be max 20.
In ANY case (not only above 2 cases) offer from market to buy intermediate product is not affecting transfer price max or min range.Right?
Trying to make up rule here !
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