A company makes power tools. The Motor Division makes a motor that Small Tools Division needs for a new product. The Motor division's variable cost of manufacturing the component is $6 per unit. The component is also available on the open market at a price of $11 per unit. The Small Tool division needs 50,000 motors per year.
a) If the Motor Division is operating at 100% capacity, explain whether a transaction will take place between the two divisions.
b) If the Motor Division has adequate capacity, should it make the motor that the Small Tools Division requires? What will the expected transfer price (be sure to include a maximum and minimum price)?
c) What principle governs the transfer of pricing between the divisions?