Division S of Kracker Company makes a part that it sells to other companies. Data on that part appear below: Division B, another division of Kracker Company, presently is purchasing 10,000 units of a similar product each period from an outside supplier for $28 per unit, but would like to begin purchasing from Division S.Suppose that Division S has ample idle capacity to handle all of Division B's needs without any increase in fixed costs or cutting into sales to outside customers. If Division S refuses to accept a transfer price of $28 or less and Division B continues to buy from the outside supplier, the company as a whole will:
A) gain $20,000 in potential profit.
B) lose $60,000 in potential profit.
C) lose $70,000 in potential profit.
D) lose $20,000 in potential profit.

Question

Division S of Kracker Company makes a part that it sells to other companies. Data on that part appear below:  Division B, another division of Kracker Company, presently is purchasing 10,000 units of a similar product each period from an outside supplier for $28 per unit, but would like to begin purchasing from Division S.Suppose that Division S has ample idle capacity to handle all of Division B's needs without any increase in fixed costs or cutting into sales to outside customers. If Division S refuses to accept a transfer price of $28 or less and Division B continues to buy from the outside supplier, the company as a whole will:
A) gain $20,000 in potential profit. 
B) lose $60,000 in potential profit. 
C) lose $70,000 in potential profit. 
D) lose $20,000 in potential profit.

Quizplus · Accepted Answer

If Division S refuses to accept a transfer price of $28 or less, Division B will continue to buy from the outside supplier for $28 per unit. However, if Division S accepted a transfer price of $28 per unit, it would generate revenue of $280,000 (10,000 units x $28 per unit). If Division S refused a transfer price of $28, it would not generate any revenue from Division B. Therefore, the company as a whole would lose out on the potential profit of $280,000 - $220,000 = $60,000.

Division S of Kracker Company Makes a Part That It