Laya Electronics Corporation makes a modem that it sells to retail stores for $75 each. The variable cost to produce a modem is $35 each; the total fixed cost is $5,000,000. Laya is operating at 80 percent of capacity and is producing 200,000 modems annually. Laya’s parent company, Ocean Corporation, notified Laya’s president that another subsidiary company, Leap Technologies, has begun making computers and can use Laya’s modem as a part. Leap needs 40,000 modems annually and is able to acquire similar modems in the market for $72 each. Under instructions from the parent company, the presidents of Laya and Leap meet to negotiate a price for the modem. Laya insists that its market price is $75 each and will stand firm on that price. Leap, on the other hand, wonders why it should even talk to Laya when Leap can get modems at a lower price.

Required

a. What transfer price would you recommend?

b. Discuss the effect of the intercompany sales on each president’s return on investment.

c. Should Laya be required to use more than excess capacity to provide modems to Leap if Leap’s demand increases to 60,000 modems? In other words, should it sell some of the 200,000 modems that it currently sells to unrelated companies to Leap instead? Why or why not?