Oriole, Inc. is a large consumer Products Company, which manufactures health and beauty products sold at grocery and drug stores throughout the country. One division, PS, does both manufacturing and shipping and operates a warehouse and transportation activity in a central location. Division PS loads trucks with products and ships the products using third-party trucking companies to its regional distribution centers.
Oriole recently started a new enterprise, Division CO, which would focus on logistics alone, providing transportation services to both other Oriole divisions and third parties. The manager of Division CO proposes using the warehouse facility of Division PS, at least to start. Employees of Division PS would load the trucks for the Division CO business as well as the Division PS business.
All divisions at Oriole are treated as profit centers with managers evaluated on division profit. The best estimates of the current activity and costs of Division PS follow:
Capacity (containers) . . . . . . . . . . . . . . . 10,000
Division PS activity (containers) . . . . . . 6,000
Variable costs (per container) . . . . . . . . $4
Fixed costs . . . . . . . . . . . . . . . . . . . . . . . $200,000
a. The current activity estimated for Division CO is 2,000 cases. The company has asked you to recommend a transfer price policy to implement. What transfer price would you recommend? Why?
b. How would the division manager for Division PS likely respond? How would you answer?
c. Another manager has identified another opportunity and also proposes using the Division PS facility. Estimated activity for this third division is expected to be 3,000 cases. How would you modify, if at all, your recommendation in part (a)?