Consider the same facts as in Self Study Question 1 but assume there is no intermediate market for flavorings.
a. If the transfer price for flavoring is set at $2 per unit, what is the minimum price that Foods Division can charge for its product and still cover its differential costs?
b. What is the optimal transfer price?
c. What profit will the two divisions report at the optimal transfer price from part (b)?
Self Study Question 1: Elmhurst Enterprises consists of two divisions: Flavorings and Foods. Flavorings Division manufactures a food flavoring that can be used in the packaged dinners that Foods Division produces and sells. Both divisions are considered profit centers, and the division managers are evaluated and compensated based on divisional profits. The following data are available concerning the flavoring and the two divisions:
|
|
Flavorings |
Foods |
|
|
Division |
Division |
|
Average units produced |
200,000 |
|
|
Average units sold |
|
200,000 |
|
Variable manufacturing |
|
|
|
cost per unit |
$1 |
|
|
Variable finishing |
|
|
|
cost per unit |
|
$4 |
|
Fixed divisional costs |
|
|
|
(unavoidable) |
$50,000 |
$200,000 |
Flavorings Division can sell all of its output to other food manufacturers for $2 per unit. Foods Division can buy flavorings from other firms (of the same quality, etc.) for $2. Foods Division sells its dinners for $10 per unit.
a. What is the optimal transfer price in this case?
b. If both division managers are given the decision authority to decide where to buy and sell flavoring, are there likely to be many disputes about the transfer price?