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The trailer division of Baxter Bicycles makes bike trailers that attach to bicycles and can carry children or cargo. The trailers have a market price of $200 each. Each trailer incurs $80 of variable manufacturing costs. The trailer division has a capacity for 40,000 trailers per year and has fixed costs of $1,000,000 per year.

1. Assume the assembly division of Baxter Bicycles wants to buy 15,000 trailers per year from the trailer division. If the trailer division can sell all of the trailers it manufactures to outside customers (and has no excess capacity), what price should be used on transfers between divisions?

2. Assume the trailer division currently only sells 20,000 trailers to outside customers and has excess capacity. The assembly division wants to buy 15,000 trailers per year from the trailer division. What is the range of acceptable prices on transfers between divisions?

Answer :

Final answer:

The transfer price between divisions of a decentralized organization ranges from the variable cost to the market price, depending on the capacity utilization. In this case, it would be $200 when there is no excess capacity and between $80-$200 when there's excess capacity.

Explanation:

In the first scenario when there is no excess capacity and Baxter Bicycles' Trailer Division can sell all trailers to external customers at $200, the transfer price should be the market price i.e. $200. This is because selling internally at a lower price would mean foregoing that difference in revenue.

However, in the second scenario, the Trailer Division has excess capacity and sells only 20,000 trailers to outside customers. As such, the additional cost of producing another trailer to be sold to the Assembly Division is only the variable cost of $80. So, the minimum transfer price should cover the variable cost, which is $80. The maximum transfer price is the market price of $200, since the Assembly Division would not pay more than the market price.

This demonstrates that variable cost, market price, and capacity are key factors in determining the transfer price in a decentralized organization.

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