Cost Management: A Strategic Emphasis (8th Edition) Chapter 19, Problem 49

Transfer Pricing;

Decision Making Phoenix Inc., a cellular communication company, has multiple business units, organized as divisions. Each divisions management is compensated based on the divisions operating income.

Division A currently purchases cellular equipment from outside markets and uses it to produce communication systems.

Division B produces similar cellular equipment that it sells to outside customersbut not to division A at this time.

Division As manager approaches division Bs manager with a proposal to buy the equipment from division B.

If it produces the cellular equipment that division A desires, division B will incur variable manufacturing costs of $60 per unit.

Relevant Information about Division B Sells 50,000 units of equipment to outside customers at $130 per unit Operating capacity is currently 80%; the division can operate at 100% Variable manufacturing costs are $70 per unit Variable marketing costs are $8 per unit Fixed manufacturing costs are $580,000

Income per Unit for Division A (assuming parts purchased externally, not internally from division B) Sales revenue $320 Manufacturing costs: Cellular equipment 80 Other materials 10 Fixed costs 40 Total manufacturing costs 130 Gross margin 190 Marketing costs: Variable 35 Fixed 15 Total marketing costs 50 Operating income per unit $140

Required 1. Division A wants to buy 25,000 units from division B at $75 per unit.

Should division B accept or reject the proposal?

How would your answer differ if (a) division A requires all 25,000 units in the order to be shipped by the same supplier, or (b) division A would accept partial shipment from division B?

2. What is the range of transfer prices over which the divisional managers might negotiate a final transfer price? Provide a rationale for the range you provide.