Question

You have been asked to resolve a transfer pricing dispute between two divisions. Division 1 is willing to sell component XYZ to Division 2 for $2.25 per unit. Division 2 says that if Division 1 doesn’t sell component XYZ to them at cost, they will buy from Component’s RUS, one of Division 1’s competitors, for $1.90 per unit. Division 1 is balking, saying that their units are far superior in quality, with a 99% efficiency, far better than Component’s RUS that is widely known to have a 3% failure rate. Due to the superior quality, Division 1 normally sells component XYZ for $2.30 per unit so they believe Division 2 is already getting a bargain.  

Question 1: What additional information would you need in order to make a decision? Please provide at least 2, but no more than 4, additional pieces of information you would need and why you would need that information to make a decision.

Question 2: Assuming Division 1 has no excess capacity, at what price should they set their transfer price to Division 2 and why?

Answer 1