Reference no: EM131565180

Problem -

Better Food Company recently acquired an olive oil processing company with an annual capacity of 2,000,000 liters, which recently has been processing and selling 1,400,000 liters per year at a market price of $4 per liter. The purpose of the acquisition was to furnish oil for the Cooking Division of Better Food. Both division managers are autonomous and act to maximize their own division's profit. The Cooking Division needs 550,000 liters of oil per year. It has been purchasing oil from outside suppliers at the market price. Production costs (per liter) of the olive oil company, now a division, are as follows:

Direct materials $1.00 per liter

Direct processing labor $0.50 per liter

Variable processing overhead $0.24 per liter

Fixed processing overhead $0.40 per liter

Management is trying to decide what transfer price to use for sales from the newly acquired company to the Cooking Division. The manager of the Olive Oil Division argues that $4, the market price, is appropriate, since the Olive Oil Division can sell a large quantity of olive oil (1,400,000 liters) to the external market at this price. The manager of the Cooking Division, however, argues that full cost of $2.14 should be used, or perhaps a lower price.

What is the transfer price, or the range of transfer prices, that will make internal trade acceptable to both divisions?