Final answer:
Transfer pricing between divisions of a company should ideally be set between the producing division's marginal cost and the alternative external purchase price, taking into account opportunity costs if the division is producing at capacity.
Step-by-step explanation:
Transfer Pricing and Profit Maximization
The student's question relates to the optimal transfer pricing between two divisions of Sako Company and whether a transfer of goods should take place from a total company perspective.
When the Audio Division sells below its capacity, the lowest transfer price it would accept is its marginal cost, which is the variable cost of $62 per speaker. The Hi-Fi Division would not want to pay more than $77, which is the outside price it can pay for similar speakers.
If the Audio Division is selling at capacity, it would need to account for the opportunity cost of not selling to external customers, thus raising the lowest acceptable transfer price. The profit-maximizing quantity for Doggies Paradise Inc., on the other hand, would require identifying the level of output where marginal revenue equals marginal cost.
The range of acceptable transfer prices depends on the relative demand and capacity utilization of the Audio Division. If the division is not at full capacity, there's a greater chance of negotiating a transfer price beneficial to both divisions.
Overall, from a company standpoint, any transfer price between the marginal cost of production and the external purchase price that keeps production within capacity constraints should be beneficial to the company as it saves on the external purchase price and utilizes the division's capacity efficiently.