Answer (A) is correct . An ideal transfer price should permit each division to operate independently and achieve its goals while functioning in the overall best interest of the firm. The production capacity of the selling division is always a consideration in setting transfer price. If Fabricating had no excess capacity, it would charge Assembling the regular market price. However, since Fabricating has excess capacity of 1,000 units, negotiation is possible because any transfer price greater than the variable cost of $20 would absorb some of the fixed costs and result in increased divisional profits. Thus, any price between $20 and $50 is acceptable to Fabricating. Any price under $50 is acceptable to Assembling because that is the price that would be paid to an outside supplier.
Answer (B) is incorrect because Assembling would not pay more than the market price of $50.
Answer (C) is incorrect because Fabricating will not be willing to accept less than its variable cost of $20.
Answer (D) is incorrect because Fabricating should be willing to accept any price between $20 and $50.
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What is the natural bargaining range for the two divisions?