Question

Benson Radio Corporation is a subsidiary of Salem Companies. Benson makes car radios that it sells to retail outlets. It purchases speakers for the radios from outside suppliers for $70 each. Recently, Salem acquired the Vernon Speaker Corporation, which makes car radio speakers that it sells to manufacturers. Vernon produces and sells approximately 130,000 speakers per year, which represents 70 percent of its operating capacity. At the present volume of activity, each speaker costs $58 to produce. This cost consists of a $47 variable cost component and an $11 fixed cost component. Vernon sells the speakers for $75 each. The managers of Benson and Vernon have been asked to consider using Vernon’s excess capacity to supply Benson with some of the speakers that it currently purchases from unrelated companies. Both managers are evaluated based on return on investment. Vernon’s manager suggests that the speakers be supplied at a transfer price of $75 each (the current selling price). On the other hand, Benson’s manager suggests a $70 transfer price, noting that this amount covers total cost and provides Vernon a healthy contribution margin.

Required

a. Based on market prices suggested by the managers, which transfer price would you recommend?

Answer 1