Jefferson Company has two divisions: Jefferson Bottles and Jefferson Juice. Jefferson Bottles makes glass containers, which it sells to Jefferson Juice and other companies. Jefferson Bottles has a capacity of 10 million bottles a year. Jefferson Juice currently has a capacity of 3 million bottles of juice per year. Jefferson Bottles has a fixed cost of $100,000 per year and a variable cost of $0.01/bottle. Jefferson Bottles can currently sell all of its output at $0.03/bottle.
a. What should Jefferson Bottles charge Jefferson Juice for bottles so that both divisions will make appropriate decentralized planning decisions?
b. If Jefferson Bottles can only sell 5 million bottles to outside buyers, what should Jefferson Bottles charge Jefferson Juice for bottles so that both divisions will make appropriate decentralized planning decisions?
a. Jefferson Bottles should charge Jefferson Juice the opportunity cost of providing the bottles. The opportunity cost to Jefferson Bottles of selling to Jefferson Juice is the market price, or $0.03/bottle.
b. Jefferson Bottles can sell 5 million bottles it currently makes, but there is no apparent market for further bottles. If there were further demand, the company would be making more bottles because the bottles provide a positive contribution margin per unit. Therefore, the opportunity cost of making more bottles is the variable cost or $0.01/bottle, which should be used as the transfer price.
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