Rapid Industries has multiple divisions. One division, Iron Products, makes a component that another division, Austin, is currently purchasing on the open market. Iron Products currently has a capacity to produce 500,000 components at a variable cost of $7.50 and a full cost of $10.00. Iron Products has outside sales of 460,000 components at a price of $12.50 per unit. Austin currently purchases 50,000 units from an outside supplier at a price of $12.00 per unit. Assume that Austin desires to use a single supplier for its component.a. What will be the effect on Rapid Industries' operating profit if the transfer is made internally? Assume the 50,000 units Austin needs are either purchased 100% internally or 100% externally.b. What is the minimum transfer price?c. What is the maximum

Question

transfer price?

What will be an ideal response?

Answer 1

a. $175,000 increase in profits = $425,000 inside cost - $600,000 outside cost
Outside cost: 50,000 units × $12 = $600,000
Inside cost: 40,000 units from excess capacity × variable cost $7.50 = $300,000 + 10,000 units × ($7.50 variable cost + $5.00 opportunity cost) = $125,000 for a total inside cost of $425,000
b. $8.50 = $425,000 inside cost/50,000 units
c. $12.00 outside market price to Austin

Profit will increase by the difference between the variable cost to manufacture and the market price to purchase, minus the opportunity cost to the selling division. The minimum transfer price with excess capacity is the variable cost, plus the opportunity cost to the selling division. The maximum transfer price is the buying division's market price.