The Alpha Division of the Carlson Company manufactures product X at a variable cost of $40 per unit. Alpha Division's fixed costs, which are sunk, are $20 per unit. The market price of X is $70 per unit. Beta Division of Carlson Company uses product X to make Y. The variable costs to convert X to Y are $20 per unit and the fixed costs, which are sunk, are $10 per unit. The product Y sells for $80 per unit.

Question

a. What transfer price of X causes divisional managers to make decentralized decisions that maximize Carlson Company's profit if each division is treated as a profit center?
b. Given the transfer price from part (a), what should the manager of the Beta Division do?
c. Suppose there is no market price for product X. What transfer price should be used for decentralized decision-making?
d. If there is no market for product X, is the operations of the Beta Division profitable?

Answer 1

a. The transfer price should be equal to the opportunity cost of Alpha Division supplying X to the Beta Division, which is the market price of $70 per unit.
b. If the manager of the Beta Division must pay $70 per unit of X, the manager of Beta Division will not be able to generate a profit and should look for other opportunities rather than processing X.
c. If there is no market for X, the opportunity cost of supplying X is the variable cost of X or $40 per unit.
d. If the Beta Division only has to pay $40 per unit of X, then Beta can operate profitably by adding $20 in variable cost and selling product Y for $80 per unit.