Cruises, Inc., operates two divisions: (1) a management division that owns and manages cruise ships in the Florida Keys and (2) a repair division that operates a dry dock in Marble Sand Florida. The repair division works on company ships, as well as other large-hull ships. The repair division has an estimated variable cost of $28.50 per labor-hour. The repair division has a backlog of work for outside ships. They charge $48.00 per hour for labor, which is standard for this type of work. The management division complained that it could hire its own repair workers for $30.00 per hour, including leasing an adequate work area.

Required:

If the repair division had idle capacity, what is the minimum transfer price that the repair division should obtain?

The minimum transfer price shoud be $28.50.

Explanation:

The transfer price is determined by two factors:

(1) The idle capacity of the business;

(2) The price in the market.

In this case, the repair division has idle capacity. This means that the transfer price could be equal to, but not lower than, the variable cost of production.

The estimated variable cost is $28.50 per labor-hour. However, this cost must be compared with the market price first, which is $30 per labor-hour. Hence, hiring labor from outside at $30 per labor-hour shall be relatively expensive and not a good option to exercise.

Since, the variable cost is lower, Cruises, Inc. should provide labor at $28.50 per labor-hour. Because there is idle capacity, this is also the minimum transfer price that should be charged.