Incremental costs and opportunity costs in transfer pricing
Division A currently sells its product to outside parties at a price of $20 per unit. It incurs variable costs of $7 per unit and fixed costs of $50,000 per month. Monthly production is typically 10,000 units, and the division purchases no materials internally.
Division B can use the product that Division A produces as a raw material in its operations. If Division B purchases the units from Division A, Division B would need to pay $1.50 per unit in shipping costs to an outside freight company. Alternatively, Division B can buy the units from a separate outside vendor at a delivered price of $21 per unit. Either way, Division B plans on meeting the demand of all its customers. The two divisions are trying to work out a mutually agreeable transfer price, and have agreed that incremental costs do not include fixed costs.
A. Assume division A has ample idle capacity.
1) Determine the INCREMENTAL cost PER UNIT of the organization as a WHOLE if Division B purchases the units INTERNALLY. Focus only on what happens if Division B purchases INTERNALLY.
2) Determine the OPPORTUNITY cost PER UNIT of Division A if Division B purchases the units INTERNALLY. Focus only on what happens if Division B purchases INTERNALLY.
3) Determine the INCREMENTAL cost PER UNIT of the organization as a WHOLE if Division B purchases the units EXTERNALLY. Focus only on what happens if Division B purchases EXTERNALLY.
4) Determine the OPPORTUNITY cost PER UNIT of Division A if Division B purchases the units EXTERNALLY. Focus only on what happens if Division B purchases EXTERNALLY.
B. Assume division A is ALREADY at full capacity before considering the interdivisional transfers.
1) Determine the INCREMENTAL cost PER UNIT of the organization as a WHOLE if Division B purchases the units INTERNALLY. Focus only on what happens if Division B purchases INTERNALLY.
2) Determine the OPPORTUNITY cost PER UNIT of Division A if Division B purchases the units INTERNALLY. Focus only on what happens if Division B purchases INTERNALLY.
3) Determine the INCREMENTAL cost PER UNIT of the organization as a WHOLE if Division B purchases the units EXTERNALLY. Focus only on what happens if Division B purchases EXTERNALLY.
Incremental Cost = 0
4) Determine the OPPORTUNITY cost PER UNIT of Division A if Division B purchases the units EXTERNALLY. Focus only on what happens if Division B purchases EXTERNALLY.
