Cost Management: A Strategic Emphasis 5th Edition by David Stout, Edward Blocher, Gary Cokins

Exercise 46

Transfer Pricing; Decision Making Phoenix Inc., a cellular communication company, has multiple divisions. Each division’s management is compensated based on the division’s 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 customers but not to division A at this time. Division A’s manager approaches division B’s manager with a proposal to buy the equipment from division B. If it produces the cellular equipment that division A desires, division B would 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 percent; the division can operate at 100 percent.

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 outside, not 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 all 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?

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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.

Step 1 of 9

Transfer Pricing:

Transfer Price is the price at which inter-departmental transfer is done.

In this, one department transfer goods or services to another department at a price determined by the departments to facilitate the transfer of goods or services within the organization.

This model is known as Transfer Pricing Model.