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

Exercise 65

Transfer Pricing; Decision Making Bramwell Adhesives, Inc, manufactures chemicals and adhesives for commercial and industrial use. Division A is currently purchasing 300 barrels per year of a required chemical (PB4) from an outside supplier for $550 per barrel. The $550 price is a competitive, fair price, but Division A is not satisfied with the service and reliability of the supplier. Fortunately, Division A has discovered that another Bramwell division, Division B, has the technology to manufacture PB4. Division B would have to purchase some new equipment to produce PB4, but the equipment is readily available and can be installed in a timely manner for $90,000. With the purchase of the machine, Division B would have the capacity to produce up to 1,000 barrels of the chemical per year. Division A would be willing to commit to a three-year contract for 300 barrels per year if the divisions could agree on a transfer price.

Division B projects the following costs per barrel for PB4.

Variable manufacturing cost	$200
Fixed costs per barrel*	300
Profit margin for Division B (20% of total cost)	100
Total projected price of PB4 to Div A	$600

* Allocation of the cost of purchased equipment over three years, based on an assumed production of 300 barrels in each of the three years.

Required

1. Is the purchase of the new equipment for $90,000 relevant to the decision to transfer internally and/or the determination of the transfer price?

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2. Should Division B sell PB4 to Division A and, if so, at what price?

Step 1 of 3

Transfer pricing is the price calculation approach where the good is been sold from one unit to another unit of same firm. There are different methods to calculate transfer pricing like variable cost method, full cost method, market price method, etc.