Wetherald Products, Incorporated, has a Pump Division that manufactures and sells a number of products, including a standard pump that could be used by another division in the company, the Pool Products Division, in one of its products. Data concerning that pump appear below: The Pool Products Division is currently purchasing 4,000 of these pumps per year from an overseas supplier at a cost of $74 per pump.Assume that the Pump Division is selling all of the pumps it can produce to outside customers. What should be the minimum acceptable transfer price for the pumps from the standpoint of the Pump Division?
A) $64 per unit
B) $74 per unit
C) $82 per unit
D) $53 per unit

Question

Wetherald Products, Incorporated, has a Pump Division that manufactures and sells a number of products, including a standard pump that could be used by another division in the company, the Pool Products Division, in one of its products. Data concerning that pump appear below:  The Pool Products Division is currently purchasing 4,000 of these pumps per year from an overseas supplier at a cost of $74 per pump.Assume that the Pump Division is selling all of the pumps it can produce to outside customers. What should be the minimum acceptable transfer price for the pumps from the standpoint of the Pump Division?
A) $64 per unit 
B) $74 per unit 
C) $82 per unit 
D) $53 per unit

Quizplus · Accepted Answer

The minimum acceptable transfer price for the pumps should be equal to or greater than the variable cost per unit. The given data does not provide the variable cost per unit, but it does provide some relevant information. The Pool Products Division is purchasing 4,000 pumps per year at a cost of $74 per pump from overseas. This cost includes not only the variable cost of the pump but also fixed costs associated with the overseas supplier. Therefore, the Pump Division can charge a transfer price higher than $74 and still provide cost savings to the Pool Products Division.

To determine the minimum acceptable transfer price, we need to calculate the variable cost per unit. Let's assume that the Pump Division produces 4,000 pumps per year for outside customers, which is the same quantity as the Pool Products Division needs. If the Pump Division is operating at full capacity, the variable cost per unit should be equal to the total variable cost incurred by the Pump Division divided by the total number of pumps produced. Let's assume the Pump Division's variable cost consists of the following:

Direct Materials: $20 per pump
Direct Labor: $15 per pump
Variable Manufacturing Overhead: $7 per pump
Total Variable Cost: $42 per pump

Therefore, the Pump Division should charge a transfer price equal to or greater than the variable cost per unit, which is $42 per pump. However, the Division should also consider the opportunity cost of selling to outside customers. If the Division sells a pump to the Pool Products Division, it loses the opportunity to sell that pump to an outside customer at the market price, which could be higher than the variable cost per unit.

Assuming the market price is $90 per pump, the Pump Division should charge a transfer price of at least $90 to capture the opportunity cost. However, this transfer price may not be acceptable to the Pool Products Division since they are currently paying $74 per pump to overseas supplier.

Therefore, the Pump Division should charge a transfer price between $74 (the price paid by the Pool Products Division) and $90 (the market price) to be acceptable to both divisions. A transfer price of $82 per pump is a reasonable choice as it provides some cost savings to the Pool Products Division while also ensuring that the Pump Division does not lose out on the opportunity cost.

Wetherald Products, Incorporated, Has a Pump Division That Manufactures and Sells