Question

Delta Company sells bells to customers for $1 each. The variable cost to manufacture the bells is 10 cents. If the rattle department, a division of the Delta Company, wants to use the bells in its new line of rattles, which of the following transfer prices can be used if there is excess capacity?

a. $0.00
b. $0.05
c. $0.11
d. $0.95
e. $1.50
f. $2.00

Answer 1

C. $0.11 and D. $0.95

Step-by-step explanation:

Given:
Company sells bells to customers = $1 = 100 cents.
Variable cost to manufacture the bells = $0.10 = 10 cents.

Formula:
There is excess capacity, the transfer price should range from the variable cost of $0.10 to the market price of $1.00.

The answer is/are: $0.10
`\leq` Transfer Price(s)
`\leq` $1.00

Reasoning:

a. $0.00 - WRONG because the transfer price is less than $0.10, therefore, the manufacture will lose money.

b. $0.05 - WRONG because the transfer price is less than $0.10; therefore, the manufacture will lose money.

c. $0.11 - CORRECT because the transfer price is between $0.10 and $1.00; therefore, the manufacture will gain money and the customers are willing to buy the bells.

d. $0.95 - CORRECT because the transfer price is between $0.10 and $1.00; therefore, the manufacture will gain money and the customers are willing to buy the bells.

e. $1.50 - WRONG because the transfer price is more than $1.00; therefore, the customers are not willing to pay for the bells.

f. $2.00 - WRONG because the transfer price is more than $1.00; therefore, the customers are not willing to pay for the bells.

Answer 2

C. $0.11

Step-by-step explanation:

When there is excess capacity and there are no incremental fixed costs the break even transfer price would be the marginal cost of production. This is the least transfer price the Bells can sell to Rattle without making a loss. The most likely transfer price then would be $0.11 which allows the bells to cover their costs and also make 1 cent in profits. Option A, B and D would all be making losses where as Option E and F are two steep a price and may be unprofitable for rattle.

Hope that helps.