Question

Lanier Manufacturing has multiple divisions that make a wide variety of products. Recently, the Bearing Division and the Wheel Division got into an argument over a transfer price. The Wheel Division needed bearings for garden tractor wheels. It normally buys its bearings from an outside supplier for $25 per set. The company's top management recently initiated a campaign to persuade the different divisions to buy their materials from within the company whenever possible. As a result, Hank Sherril, the purchasing manager for the Wheel Division, received a letter from the vice president of Purchasing, ordering him to contact the Bearing Division to discuss buying bearings from this division.

To comply with this request, Hank from the Wheel Division called Mary Plimpton of the Bearing Division, and asked the price for 15,000 bearings. Mary responded that the bearings normally sell for $36 per set. However, Mary noted that the Bearing Division would save $3 on marketing costs by selling internally, and would pass this cost savings on to the Wheel Division. She further commented that they were at full capacity, and therefore would not be able to provide any bearings presently. In the future, if they had available capacity, they would be happy to provide bearings.

Hank responded indignantly, “Thanks but no thanks.” He said, “We can get all the bearings we need from Falk Manufacturing for $25 per set, and their quality is acceptable for our product.” Mary snorted back, “Falk makes low-quality bearings. We incur a total cost of $22 per unit for units we sell externally. Our bearings can withstand heat of 2,000 degrees centigrade and are good to within .00001 centimeters. If you guys are happy buying low-quality bearings, then go ahead and buy from Falk.”

Two weeks later, Hank's boss from the central office stopped in to find out whether he had placed an order with the Bearing Division. Hank responded that he would sooner buy his bearings from his worst enemy than from the Bearing Division.

Instructions

With the class divided into groups, prepare answers to the following questions.

a. Why might the company's top management want the divisions to start doing more business with one another?

b. Under what conditions should a buying division be forced to buy from an internal supplier? Under what conditions should a selling division be forced to sell to an internal division rather than to an outside customer?

c. The vice president of Purchasing thinks that this problem should be resolved by forcing the Bearing Division to sell to the Wheel Division at its cost of $22. Is this a good solution for the Wheel Division? Is this a good solution for the Bearing Division? Is this a good solution for the company?

d. Provide at least two other possible solutions to this problem. Discuss the merits and drawbacks of each.

Answer 1

a. Why might the company's top management want the divisions to start doing more business with one another?	1)The top Management wants divisions to start doing more business with one another , In order to increase companies overall profit 2) Utilizing its resources to the optimum.
b. Under what conditions should a buying division be forced to buy from an internal supplier? Under what conditions should a selling division be forced to sell to an internal division rather than to an outside customer?	Company's Top management have to come up a solution where both the division agrees to enter into transaction such price is called transfer price. 1)Buying division Wheel Will only be agree to buy if he gets the product belove the price of 25 $. 2)Selling division have utilized its full capacity it will sell at a price =variable cost + Opportunity cost to sell outside
c. The vice president of Purchasing thinks that this problem should be resolved by forcing the Bearing Division to sell to the Wheel Division at its cost of $22. Is this a good solution for the Wheel Division? Is this a good solution for the Bearing Division? Is this a good solution for the company?	1) price 22$ is good price for Wheel division since it is less then price from outside supplier. and saves 3$ 2) However for Bearing division the total cost is 22$ well saving marketing cost 3$ in case of inter division department the cost will be 19$ . Hence company can earn 3 $ if sold at 22$ but however the bearing company earns 14 $ when he sold outside. hence in order to save 3$ The company faces the lose of 11 $ 3) Hence this is not a good solution.
d. Provide at least two other possible solutions to this problem. Discuss the merits and drawbacks of each.	1) Setting Transfer price = Variable cost + Opportunity cost 2) Selling at price equall to outside supplier =25 $ Merit : This will Ensure the converage of variable cost in the both cases Demerits : Well in first case Fixed cost is ignored and in second case Earning opportunity is reduced.