Question

The Hong Kong Home Products company has two divisions, Appliances and Kitchen Designs. The Applilance division supplies refrigerators to the Kitchen Designs division. The capacity of the appliance division is 2000 refrigerators per year. The variable cost of production is $60 per refrigerator. The fixed cost per unit is $100 (based on a volume of 2000 units). The market price for the category of refrigerator is $225 per unit.

1. If the Appliance division is at capacity, what is the optimal transfer price?

2. If the Appliance division has excess capacity, what is the best decision for the company, as a whole, buy inside or outsource?

3. What transfer price with divisional decentralization will provide the optimal solution for the company in part 2?

4. What other factors would become important if the Appliance division has excess capacity and Kitchen Designs division is located in Manila, Philippines? Assume that the applicable tax rate in the Philippines is 30% and Hong Kong is 15%.

Answer 1

1. $ 225 the market price would be the optimat transfer price
2. Buy inside and save the extra cost kithcen division gives to the outside vendor/
3. Transfer price of $ 60 + $ 100 = $ 160 would give appropriate solutuion
4. The other factors would be:
   • The savings in the cost to the company overall because of the tax parity if the Appliance division sells to KD at higher price. This way AD has to pay only 15% of the tax on profts while KD can save on the purchase cost by lowering the margin and suebsequent tax paymnets.
   • The stability in the taxation rates
   • The reduction or increase in the cost of the company operation