Question

Chen Company's Small Motor Division manufactures a number of small motors used in household and office appliances. The Household Division of Chen then assembles and packages such items as blenders and juicers. Both divisions are free to buy and sell any of their components internally or externally. The following costs relate to small motor LN233 on a per unit basis.

Fixed cost per unit $5.00
Variable cost per unit $11.00
Selling price per unit $35.00
A) Assuming that the Small Motor Division has excess capacity, compute the minimum acceptable price for the transfer of small motor LN233 to the Household Division.
B) Assuming that the Small Motor Division does not have excess capacity, compute the min-imum acceptable price for the transfer of the small motor to the Household Division.
C) Explain why the level of capacity in the Small Motor Division has an effect on the transfer price.

Answer 1

A) Assuming that the Small Motor Division has excess capacity, compute the minimum acceptable price for the transfer of small motor LN233 to the Household Division.

If there is excess capacity, then LN233 can be sold only considering variable costs = $11 per unit.

B) Assuming that the Small Motor Division does not have excess capacity, compute the minimum acceptable price for the transfer of the small motor to the Household Division.

If the Small Motor Division currently produces and sells at full capacity, then the minimum selling price = variable cost + opportunity costs = $35 per unit (basically the same price as any outside buyer).

C) Explain why the level of capacity in the Small Motor Division has an effect on the transfer price.

If there is excess capacity, then the marginal cost of producing LN233 is equal to the variable cost, but if it is operating at full capacity, if it sells below normal price it would be losing money. One unit sold to another division is one less unit sold to an outside customer = less profit.