Reference no: EM132542738

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 $42 of variable cost per unit of L246 and allocates $66 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 $51 in variable cost per unit. In addition to the cost of L246, West division incurs $71 in variable cost and $110 in allocated fixed cost to make each unit of Zilbanf, which sells for $413. If necessary, West could contract with an outside supplier for a slightly different part, M246, that costs $165 per unit and would require an additional $16 in cost to convert it into an equivalent of L246. It will be in the best interest of Lexington for the transfer to occur.

Question 1: 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)?

Question 2: 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)?

Question 3: The CEO of Lexington decides to impose a transfer price since the two divisions cannot agree. She chooses the highest feasible price. Her reasoning is that selling for a high price is better for Lexington's profit. Is the CEO's reasoning sound? Explain why or why not.