The Ink and Paper Divisions are part of the same company. Currently the Paper Division buys a part ingredient from Ink for $192. The Ink Division wants to increase the price of the part it sells to Paper by $48 to $240. The manager of Paper has stated that it cannot afford to go that high, as it will decrease the division's profit to near zero. Paper can buy the part from an outside supplier for $224. The cost data for the Ink Division is as follows:
If Ink ceases to produce the parts for Paper, it will be able to avoid one-third of the fixed manufacturing overhead. The Ink Division has excess capacity but no alternative uses for its facilities.
-What is the minimum transfer price that should be charged?
A) $240.00
B) $224.00
C) $194.40
D) $188.00

Question

The Ink and Paper Divisions are part of the same company. Currently the Paper Division buys a part ingredient from Ink for $192. The Ink Division wants to increase the price of the part it sells to Paper by $48 to $240. The manager of Paper has stated that it cannot afford to go that high, as it will decrease the division's profit to near zero. Paper can buy the part from an outside supplier for $224. The cost data for the Ink Division is as follows:
  If Ink ceases to produce the parts for Paper, it will be able to avoid one-third of the fixed manufacturing overhead. The Ink Division has excess capacity but no alternative uses for its facilities.
-What is the minimum transfer price that should be charged?
A) $240.00 
B) $224.00 
C) $194.40 
D) $188.00

Quizplus · Accepted Answer

The minimum transfer price should be equal to the marginal cost to the Ink Division. The marginal cost is the variable cost plus the avoided fixed cost.

Variable cost = $192 (current price) - $48 (proposed price increase) = $144

Avoided fixed cost = $96 (one-third of $288 fixed overhead)

Marginal cost = $144 + $96 = $240

Therefore, the minimum transfer price should be $240. However, since Paper cannot afford it, the next best option is for Paper to buy from the outside supplier at a price of $224. Any lower than this and Ink will be selling the parts at a loss, which is not sustainable for the company.

The Ink and Paper Divisions Are Part of the Same