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Hello sir, even though i got the Transfer Pricing chapter all correct i didnt understand this question at all. Could you explain me this question as thorough as you can cause i dont even see the logic. P.S ( ive got all the mcq’s right in the section but this one makes me mad):Epsilon has 2 divisions, P and Q. Division P makes a component which it can only sell to Division Q. Current information for Division P is as follows :
MC p.u = $ 240
trf price of the component $ 396
Total production and sales per year 4000
Specific fixed costs of divison P $24000Alpha Co has offered to sell the component to Division Q for $350 per unit. If Division Q accepts this offer Division P will be closed.
If Division Q accepts Alpha’s offer, what will be the impact on profits for the group as a whole?
2)Extra question: why we not using 396. And substracting only 240 ? I do know that me weakest point in F5 is chapter on SHort-term decision making and so I dont really understand why we not taking account of spare capacity that’s left off as lost contribution or lost space of smth when shutting down the product line or taking the product of the market. The same idea here. Why we not taking account of SAVING THOSE (396-350) MONEYS THAT WE ARE ACTUALLY SAVING AND COMPANY IS PAYING $46,000 LESS AND IT SHOULD BE TAKEN UNDER ACCOUNT WHEN SHUTTING DOWN DIVISION P. PLEASE SIR HELP ME WITH THAT…
The current transfer price is irrelevant as far as the total profit of Epsilon is concerned – it is income for one division but cost for the other division. Whatever the transfer price is the total profit of the whole company will stay the same.
At the moment the cost to Epsilon of producing the product is 240. If they accept Alphas offer then it will cost 350. So an extra cost of 110 per unit which for 4,000 units will mean an extra total cost of 440,000.
However because Division P will be closed, there will be a saving of 24,000 fixed costs (have you typed the correct figure for the fixed costs?).
So there will be a net extra cost of 440,000 – 24,000 = 416,000 and therefore the profit will fall by 416,000.
(Please don’t type in capital letters 🙂 )
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