Dalton Industries, Inc., has two major operating divisions, the Furniture Division and the Electronics Division. The company's main product is a deluxe entertainment center. The centers' components (shelving, drawers, and glass cabinet doors) are manufactured by the Furniture Division, and the Electronics Division produces all electronic components (HDTV receivers, portable electronics docking stations, speakers, etc.) and assembles the sets. The company has a decentralized organizational structure.

The Furniture Division not only supplies entertainment centers to the Electronics Division but also sells shelving, drawers, and cabinet doors to other manufacturers. The following unit cost breakdown for a deluxe entertainment center was developed based on a typical sales order of 40 entertainment centers:

Direct materials................................................... $ 32.00

Direct labor..........................................................15.00

Variable overhead...................................................12.00

Fixed overhead..................................................... 18.00

Variable selling expenses........................................... 9.00

Fixed selling expenses.............................................. 6.00

Fixed general and administrative expenses...................... 8.00

Total unit cost................................................... $100.00

The Furniture Division's usual profit margin is 20 percent, and the regular selling price of a deluxe entertainment center is $120. The division's managers recently decided that $120 will also be the transfer price for all intracompany transactions.

Managers at the Electronics Division are unhappy with that decision. They claim that the Furniture Division will show superior performance at the expense of the Electronics Division. Competition recently forced the company to lower its prices. Because of the newly established transfer price for the cabinet, the Electronics Division's portion of the profit margin on deluxe entertainment centers was lowered to 18 percent. To counteract the new intracompany transfer price, the managers of the Electronics Division announced that effective immediately, all furniture components of each center (shelving, drawers, and glass cabinet doors) will be purchased from an outside supplier, in lots of 200 entertainment centers at a unit price of $110 per center. The company president, Jack Dalton, has called a meeting of both divisions to negotiate a fair intracompany transfer price. The following prices were listed as possible alternatives:

Current market price..................................... $120 per entertainment center

Current outside purchase price

(This price is based on a large-quantity purchase discount.

It will cause increased storage costs for the Electronics Division.)...$110 per entertainment center

Total unit manufacturing costs plus a 20 percent profit margin:

$77.00 + $15.40 ........................................................$92.40 per entertainmentcenter

Total unit costs excluding variable selling expenses plus a

20 percent profit margin:............................. $91.00 + $18.20 $109.20 per entertainmentcenter

1. What price should be established for intracompany transactions? Defend your answer by showing the shortcomings of each alternative.

2. If there were an outside market for all units produced by the Furniture Division at the $120 price, would you change your answer to 1? Why?