Rhinesch Corporation has two divisions: the Motor Division and the Pump Division. The Motor Division supplies the motors used by the Pump Division. The Pump Division produces approximately 10,000 pumps annually. Thus, it receives 10,000 motors from the Motor Division each year. The market price of these motors is $320. The total variable cost of the motor is $195 per unit. The market price of the pumps is $500. The unit variable cost of each pump, excluding the cost of the motor, is $75.
The Motor Division is currently operating at full capacity, producing 20,000 motors per year (10,000 of which are transferred to the Pump Division). The demand for the motors is so great that all 20,000 units could be sold to outside customers if the Pump Division acquired its motors elsewhere. The Motor Division uses the full market price of $320 as the transfer price charged to the Pump Division.
The manager of the Pump Division asserts that the Motor Division benefits from the intercompany transfers because of reduced shipping costs. As a result, he wants to negotiate a lower transfer price of $310 per unit.
a. Compute the contribution margin earned annually by each division and by the company as a whole using the current transfer price.
b. Compute the contribution margin that would be earned annually by each division and by the company as a whole if the discounted transfer price were used.
c. What issues and concerns should be considered in setting a transfer price for intercompany transfers of motors?