Question

Transfer Pricing: Various Computations

Corning Company has a decentralized organization with a divisional structure. Two of these divisions are the Appliance Division and the Manufactured Housing Division. Each divisional manager is evaluated on the basis of ROI.

The Appliance Division produces a small automatic dishwasher that the Manufactured Housing Division can use in one of its models. Appliance can produce up to 21,000 of these dishwashers per year. The variable costs of manufacturing the dishwashers are $106. The Manufactured Housing Division inserts the dishwasher into the model house and then sells the manufactured house to outside customers for $70,000 each. The division's capacity is 4,410 units. The variable costs of the manufactured house (in addition to the cost of the dishwasher itself) are $41,000.

Required:

Assume each part is independent, unless otherwise indicated.

1. Assume that all of the dishwashers produced can be sold to external customers for $316 each. The Manufactured Housing Division wants to buy 4,410 dishwashers per year. What should the transfer price be?
$  per unit

2. Refer to Requirement 1. Assume $20 of avoidable distribution costs. Identify the maximum and minimum transfer prices.

Maximum	$  per unit
Minimum	$  per unit

Identify the actual transfer price, assuming that negotiation splits the difference.
$  per unit

3. Assume that the Appliance Division is operating at 75 percent capacity. The Manufactured Housing Division is currently buying 4,410 dishwashers from an outside supplier for $286 each. Assume that any joint benefit will be split evenly between the two divisions. What is the expected transfer price?
$  per unit

How much will the profits of the Appliance Division increase, assuming that it sells the extra 4,410 dishwashers internally?
$

How much will the profits of the firm increase under this arrangement?
$

Answer 1

1.Since there is no excess capacity, the transfer price should be equal to the market price i.e. $316 per unit

2.Maximum Price = Market Price = $316

Minimum price = Market price – avoidable cost

= 316-20 = $296

Actual Price = $296 + 20/2 = $306 per unit

3.Since there is spare capacity, the relevant cost of transfer is the variable cost

i.e. $106 per unit

Hence, expected Transfer Price = 106 + (286-106)/2 = $196

Increase in Profits = 4,410*90 = $396,900

Increase in Profit of the year = 180*4,410 = $793,800