Division A produces a part with the following characteristics: $\begin{array}{llr}
\text { Capacity in units } &50,000\
\text { Selling price per unit } &\$30\
\text { Variable cost per unit } &\$18\
\text { Fixed cost per unit} &\$3\
\end{array}$
Division B, another division in the company, would like to buy this part from Division A. Division B is presently purchasing the part from an outside source at $28 per unit. If Division A sells to Division B, $1 in variable costs can be avoided. Suppose Division A is currently operating at capacity and can sell all of the units it produces on the outside market for its usual selling price. From the point of view of Division A, any sales to Division B should be priced no lower than:
A) $27
B) $20
C) $29
D) $28
E) $21

Question

Division A produces a part with the following characteristics: $\begin{array}{llr}
  \text { Capacity in units } &50,000\
 \text { Selling price per unit } &\$30\
 \text { Variable cost per unit } &\$18\
 \text {  Fixed cost per unit} &\$3\
\end{array}$
 Division B, another division in the company, would like to buy this part from Division A. Division B is presently purchasing the part from an outside source at $28 per unit. If Division A sells to Division B, $1 in variable costs can be avoided. Suppose Division A is currently operating at capacity and can sell all of the units it produces on the outside market for its usual selling price. From the point of view of Division A, any sales to Division B should be priced no lower than:
A) $27
B) $20
C) $29
D) $28
E) $21

Quizplus · Accepted Answer

Division A should set the internal transfer price at no lower than the outside market selling price minus the variable cost savings from selling internally. 
Thus, the minimum transfer price should be $28 - $1 = $27.
However, if Division A can sell all of the units it produces on the outside market, it has an opportunity cost of $28 for each unit it sells internally instead of on the outside market. 
Therefore, the transfer price should be no lower than the outside market price, which is $28. 
Hence, the best choice is C) $29, which is higher than both the opportunity cost of $28 and the minimum transfer price of $27.

Division a Produces a Part with the Following Characteristics Division B, Another Division in the Company, Would Like to