Peppertree Company has two divisions, East and West. Division East manufactures a component that Division West uses. The variable cost to produce this component is $1.48 per unit; full cost is $2.01. The component sells on the open market for $4.94. Assuming Division East has excess capacity, what is the lowest price Division East will accept for the component?

The lowest price that Division East will accept for the component is:

$1.48 per unit.

Explanation:

a) Data:

Variable product cost = $1.48

Full cost = $2.01 (Variable + Fixed costs)

Market price = $4.94

b) The variable product cost of $1.48 is the direct cost for producing the component, which includes the direct materials, direct labor, and direct overhead.  The full cost of $2.01 includes other fixed costs (indirect materials, indirect labor, and indirect overhead), which cannot be directly traced to the component.  The market price is the selling price, which includes the full cost and the profit margin (markup) which is added as compensation for the manufacturing effort.

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