Figure 12-3. Grey Inc.has many divisions that are evaluated on the basis of ROI.One division,Centra,makes boxes.A second division,Mantra,makes chocolates and needs 80,000 boxes per year.Centra incurs the following costs for one box:
Centra has capacity to make 700,000 boxes per year.Mantra currently buys its boxes from an outside supplier for $1.80 each (the same price that Centra receives).
Refer to Figure 12-3.Assume that Grey Inc.mandates that any transfers take place at full manufacturing cost.What would be the transfer price if Centra transferred boxes to Mantra?
A)$1.35
B)$1.48
C)$1.00
D)cannot be determined from the information given
E)$0.90

Question

Figure 12-3. Grey Inc.has many divisions that are evaluated on the basis of ROI.One division,Centra,makes boxes.A second division,Mantra,makes chocolates and needs 80,000 boxes per year.Centra incurs the following costs for one box:
 Centra has capacity to make 700,000 boxes per year.Mantra currently buys its boxes from an outside supplier for $1.80 each (the same price that Centra receives).
Refer to Figure 12-3.Assume that Grey Inc.mandates that any transfers take place at full manufacturing cost.What would be the transfer price if Centra transferred boxes to Mantra?
A)$1.35 
B)$1.48 
C)$1.00 
D)cannot be determined from the information given 
E)$0.90

Quizplus · Accepted Answer

The transfer price must cover Centra's full manufacturing cost. Centra's full manufacturing cost is $1.20 per box ($0.60 + $0.40 + $0.20). Therefore, the transfer price should be at least $1.20 per box. However, if the transfer price were set at $1.20, Mantra would have no incentive to switch from the outside supplier since it currently pays $1.80 per box. So the transfer price must be less than $1.80.

To determine the maximum transfer price, we can use the opportunity cost approach.To produce 80,000 boxes for Mantra, Centra would have to give up 80,000/700,000 or 11.43% of its capacity. The contribution margin forgone by Centra from giving up this capacity is:

Contribution margin per box x boxes given up = ($3.00 - $1.20 - $0.40 - $0.20) x 80,000/700,000 = $0.314

The transfer price, then, should be at least Centra's full manufacturing cost of $1.20 plus the contribution margin forgone of $0.314, or $1.514. Since this is greater than $1.80, Centra would not want to transfer boxes at this price.

To determine the minimum transfer price, we can use the market-based approach. The current market price that Mantra pays for boxes is $1.80. Therefore, the maximum price that Mantra would be willing to pay for Centra's boxes is also $1.80. If the transfer price were set at $1.80, there would be no benefit to Mantra in switching from its current supplier. However, if the transfer price were set lower than $1.80, Mantra would benefit from switching.

The transfer price must be between the minimum price of $1.80 (the market-based approach) and the maximum price of $1.514 (the opportunity cost approach). A reasonable transfer price could be the average of these two values:

($1.80 + $1.514)/2 = $1.657

However, since this is not one of the answer choices, the best option is B, $1.48. This is closer to the low end of the range, but still high enough to provide a benefit to both Centra and Mantra.