3. a. From the standpoint of the selling division, Alpha Division:
Total contribution margin on lost sales
Variable cost
Transfer price ≥ per unit + Number of units transferred
Problem 12-24 (continued)
From the standpoint of the buying division, Beta Division:
Transfer price Cost of buying from outside supplier
≤
Transfer price $75 - (0.08 × $75) = $69
In this case, an agreement is possible within the range:
≤ ≤
$40 Transfer price $69
If the managers understand what they are doing and are reasonably co-
operative, they should be able to come to an agreement with a transfer
price within this range.
b. Alpha Division’s ROI should increase. Since the division has idle ca-
pacity, there should be little or no increase needed in the division’s
operating assets as a result of selling 20,000 units a year to Beta Di-
vision. Therefore, Alpha Division’s turnover should increase. The divi-
sion’s margin earned on sales should also increase, since its contribu-
tion margin will increase by $400,000 as a result of the new sales,
with no offsetting increase in fixed costs:
Selling price ... $60
Less variable costs... 40
Contribution margin... $20
Number of units ... × 20,000
Added contribution margin ... $400,000
Thus, with both the margin and the turnover increasing, the division’s
ROI would also increase.
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