The Lilly Company’s Switch Division manufactures an electrical switching unit that can be sold either to outside customers or to the Fiber Optics Division of the Lilly Company

The Lilly Company’s Switch Division manufactures an electrical switching unit that can be sold either to outside customers or to the Fiber Optics Division of the Lilly Company. Selected operating data on the two divisions are given below:

                                  Switch Division:

                                                Unit selling price to outside customers…………….         $            80

                                                Variable production cost per unit…………………..                        45

                                                Variable selling and administrative

                                                     expense per unit………………………………...                6

                                                Fixed production cost in total………………………   400,000*

                                  Fiber Optics Division:

                                                Outside purchase price per unit                                                       78

                     *Capacity 40,000 units per year.

The Fiber Optics Division now purchases the switch from an outside supplier at the regular $78 intermediate price, due to some significant negotiating by that division and some excess supply in the market place which should continue for some time. Since the switch manufactured by the Switch Division is of the same quality and type used by the Fiber Optics Division, consideration is being given to buying internally rather than from the outside supplier. As the company’s president stated, “It’s just plain smart to buy and sell within the corporate family.”

A study has determined that the variable selling and administrative expenses of the Electronics Division would be cut by one-third for any sales to the Fiber Optics Division. Top management wants to treat each division as an autonomous unit with independent profit responsibility.

Required:

1. Assume that the Switch Division is currently selling only 30,000 units per year to outside customers and that the Fiber Optics Division needs 10,000 units per year.
   1. What is the lowest acceptable transfer price from the perspective of the Switch Division? Explain.
   2. What is the highest acceptable transfer price from the perspective of the Fiber Optics Division? Explain.

2. Now assume that the Switch Division is operating at full capacity, due to some long-term contracts agreed to a

few years ago. What is the lowest acceptable transfer price from the perspective of the Switch Division now? Should this transfer be done internally for the benefit of the company as a whole? Why or why not?