Question

Sheffield Company manufactures power tools. The Electric Drill Division (an investment center) can purchase the motors for the drills from the Motor Division (another investment center) or from an outside vendor. The cost to purchase from the outside vendor is \(20. The Motor Division also sells to outside customers. The motor needed by the Electric Drill Division sells for \)25 to outside customers and has a variable cost of $15. The Motor Division has excess capacity.

21. If Sheffield Company allows division managers to negotiate transfer prices, what is the minimum amount the manager of the Motor Division should consider?

22. What is the maximum transfer price the manager of the Electric Drill Division should consider?

Short answer

Themaximum transfer price considered by the manager should be $20.

Step-by-step solution

Meaning of Transfer Price

The term transfer price is used to denote thetransfer price paid for goods or services from the organization’s one department to another unit. Such other units can be in the same country or other countries.

Consideration of minimum amount

As per the given information, motor division has access capacity then the utilization of such capacity will facilitate the company to negotiatetransfer prices. Hence, in the given scenario the motor division should consider the equivalent to the cost i.e. $15.

Maximum transfer price

In addition, the maximum transfer price considered by the manager should be equivalent to the price offered by the outsider vendor i.e. $20. In such a way, the company can have transfer pricing of maximum ofout of pocket expense.