Transfer Pricing:
Smith Company has two divisions, Division A and Division B.
Division A currently sells components to Division B for $10 per unit.
The cost of Division A to produce a component follows:
Variable cost per unit $5
Fixed cost per unit $2 (based on 100,000 units)
Division A typically sells 40,000 components to Division B and 40,000 components to external customers.
The manager of Division B is considering buying components from an outside supplier that submitted a bid of $8.
Q1. Calculate the cost savings to Division B if the manager decides to purchase the component externally.
Q2. Assume Division A cannot replace lost sales in the short run if Division B purchases components externally. How does the fixed cost per unit change?
Q3. From the perspective of the corporation as a whole, should Division B purchase the components externally? Explain.
Q4. What other factors should Division B’s management consider in its decision of whether to buy from an outside source?