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 28,000 of these dishwashers per year. The variable costs of manufacturing the dishwashers are $102. The Manufactured Housing Division inserts the dishwasher into the model house and then sells the manufactured house to outside customers for $71,000 each. The division's capacity is 5,600 units. The variable costs of the manufactured house (in addition to the cost of the dishwasher itself) are $42,700.

Required:

Assume each part is independent, unless otherwise indicated.

1. Assume that all of the dishwashers produced can be sold to external customers for $314 each. The Manufactured Housing Division wants to buy 5,600 dishwashers per year. What should the transfer price be?
$ fill in the blank 1 per unit

2. Refer to Requirement 1. Assume $18 of avoidable distribution costs. Identify the maximum and minimum transfer prices.

Maximum	$ fill in the blank 2 per unit
Minimum	$ fill in the blank 3 per unit

Identify the actual transfer price, assuming that negotiation splits the difference.
$ fill in the blank 4 per unit

3. Assume that the Appliance Division is operating at 75 percent capacity. The Manufactured Housing Division is currently buying 5,600 dishwashers from an outside supplier for $280 each. Assume that any joint benefit will be split evenly between the two divisions. What is the expected transfer price?
$ fill in the blank 5 per unit

How much will the profits of the Appliance Division increase, assuming that it sells the extra 5,600 dishwashers internally?
$ fill in the blank 6

How much will the profits of the firm increase under this arrangement?
$ fill in the blank 7

Answer 1

Solution:

1)

Particulars	Amount
Outlay cost:
Standard variable cost of production	$102
Total outlay cost	$102
opportunity cost
Selling price per unit in external market	$314
Less: Variable cost of production	($102)
Opportunity cost	$212
Transfer price ($212+$102)	$314

2)

Particulars	Amount
Outlay cost:
Standard variable cost of production	$102
Less: Avoidable outlay cost	($18)
Total outlay cost	$84
opportunity cost
Selling price per unit in external market	$314
Less: Variable cost of production	($102)
Opportunity cost	$212
Transfer price (212+84)	$296

Spits difference = (Maximum+minimum) /2

=($296+$317)/2

=$613/2

=$306.5

3a)

Expected tarnsfer price =$102+($280-$102)(-.5

=$191

3b)

Profit=($191-$102)*5,600

=$89*5,600

=$498,400

3c)

Profit=($280 -$102)*5,600

=$178*5,600

=$996,800

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