Division S makes a component with a variable cost of $30 and a full cost of $42 per unit. It has spare capacity and there is no external market for the component. Division R can buy an equivalent component from an outside supplier for $55. Within what range should the transfer price lie to encourage goal-congruent decisions?

Correct answer: A) Between $30 and $55

Explanation

With spare capacity, the supplying division's opportunity cost is zero, so the minimum transfer price is its variable cost of $30. The maximum the receiving division would pay is the external price of $55. Any price in this range should lead both managers to favour the internal transfer. Using full cost ($42) as the floor ignores the spare capacity, and a price above $55 would push Division R to buy externally.