The Pen and Pencil Divisions are part of the same company. Currently the Pencil Division buys a part ingredient from Pen for $96. The Pen Division wants to increase the price of the part it sells to Pencil by $24 to $120. The manager of Pencil has stated that it cannot afford to go that high, as it will decrease the division's profit to near zero. Pencil can buy the part from an outside supplier for $112. The cost data for the Pen Division is as follows:
If Pen ceases to produce the parts for Pencil, it will be able to avoid one-third of the fixed manufacturing overhead. The Pen Division has excess capacity but no alternative uses for its facilities.
-What is the minimum transfer price that should be charged?
A) $120.00
B) $112.00
C) $97.20
D) $94.00

Question

The Pen and Pencil Divisions are part of the same company. Currently the Pencil Division buys a part ingredient from Pen for $96. The Pen Division wants to increase the price of the part it sells to Pencil by $24 to $120. The manager of Pencil has stated that it cannot afford to go that high, as it will decrease the division's profit to near zero. Pencil can buy the part from an outside supplier for $112. The cost data for the Pen Division is as follows:
  If Pen ceases to produce the parts for Pencil, it will be able to avoid one-third of the fixed manufacturing overhead. The Pen Division has excess capacity but no alternative uses for its facilities.
-What is the minimum transfer price that should be charged?
A) $120.00 
B) $112.00 
C) $97.20 
D) $94.00

Quizplus · Accepted Answer

The minimum transfer price that should be charged is the variable cost per unit plus the opportunity cost per unit.

Variable cost per unit = cost of part ingredient = $96

Opportunity cost per unit = one-third of fixed manufacturing overhead 
= (1/3) x $48 = $16

Therefore, minimum transfer price = $96 + $16 = $112

This matches the price that Pencil can buy from an outside supplier, so the best choice is to buy from the outside supplier. Answer choice B is the only correct option.

The Pen and Pencil Divisions Are Part of the Same