Some students may erroneously say that the new market

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Some students may erroneously say that the “new” market price of $270 is the appropriatetransfer price. They may claim that the general guideline says that the transfer price should be $90 +($270 – $90) = $270, the market price. This conclusion assumes a perfect market. However, in thiscase, there are imperfections in the intermediate market. That is, the market price is nota goodapproximation of alternative revenue. If a division’s sales are heavy enough to reduce market prices,marginal revenue will be less than market price.It is true that either $270 or $255 will lead to the correct decision by B in this case. Butsuppose that B’s variable costs were $90 instead of $120. Then B would buy at a transfer price of$255 (but not at a price of $270, because then B would earn no contribution per unit [$360 – ($270+ $90)]. Note that if B’s variable costs were $90, transfers would be desirable:Division A contribution is:[900  ($275 – $90)] + [300  ($255 – $90)]$216,000Division B contribution is:300  [$360 – ($255 + $90)]4,500Total contribution$220,500Or the same facts can be analyzed for the company as a whole:Sales of intermediate product,900  ($275 – $90)=$166,500Sales of final products,300  [360 – ($90 + $90)]=54,000Total contribution$220,500If the transfer price were $275, B would not accept the transfer and would not earn anycontribution. As shown above, Division A and the company as a whole will earn a total contributionof $216,000 instead of $220,500.
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ALTERNATIVE PRESENTATION(by James Patell)Company Viewpointa:Sell 1,200 units outside at $270 per unitb:Sell 900 units outside at $275 per unit, transfer300Price$270Price$275Variable cost per unit90Variable cost per unit90Contribution$ 180 1,200 = $216,000Contribution$ 185900 = $166,500Total contribution given up if transfer occurs= $216,000 $166,500 = $49,500On a per-unit basis, the relevant costs are:+ = Transfer price$90+ =$255By formula, costs are:+ [lost opportunity to sell 300 units at $270 per unit, for contribution of $185 per unit] [gain when1st 900 units sell at $275 per unit instead of $270 per unit]= $90 + = $90 + $180 – $15 = $25533 per pound!

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