Reference no: EM132896285
Problem - Lexington Inc. has two divisions. East division sells a component (L246) to West division. West then assembles a product, Zilbanf, using L246 and sells it to customers. East division incurs $47 of variable cost per unit of L246 and allocates $55 of fixed cost to each unit. East's factory has limited space, so every unit of L246 it produces means one less unit of L247 is made. While L246 is only sold to West division, East division sells L247 to outside customers for $126 per unit while incurring $45 in variable cost per unit. In addition to the cost of L246, West division incurs $74 in variable cost and $119 in allocated fixed cost to make each unit of Zilbanf, which sells for $405. If necessary, West could contract with an outside supplier for a slightly different part, M246, that costs $157 per unit and would require an additional $18 in cost to convert it into an equivalent of L246. It will be in the best interest of Lexington for the transfer to occur.
Required -
a) What is the lowest transfer price that will ensure that both divisions will voluntarily participate in the transfer (ie, if the price was lower than this level, one of the divisions would refuse to participate)?
b) What is the highest price that ensures both divisions will voluntarily participate in the transfer (ie, if the price was higher than this level, one of the divisions would refuse to participate)?
c) Assume that Lexington's CFO is lazy and chooses a transfer price as full cost of production +10% profit margin (ie, the price is 10% higher than the total cost per unit for the producer). What transfer price will Lexington set for L246 using this cost plus rule?
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