A selling division has spare capacity and makes a component at a variable cost of £12 and a full cost of £16. The external market price is £20. What is the minimum transfer price to the buying division?
Answer and explanation
Correct answer: A. £12
- Step 1: With spare capacity there is no lost external sale, so no opportunity cost.
- Step 2: The minimum price is the marginal cost: £12.
Answer
£12.
Why not the others: £16 includes fixed cost that will be incurred anyway. £20 is the maximum, since the buyer could buy externally at that price. £4 is the difference between the full cost and the variable cost, which is not a price.
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