Question

P22-26
The Shamrock Company manufactures and sells television sets. Its assembly division​ (AD) buys television screens from the screen division​ (SD) and assembles the TV sets. The​ SD, which is operating at​ capacity, incurs an incremental manufacturing cost of $90per screen. The SD can sell all its output to the outside market at a price of $130 per​ screen, after incurring a variable marketing and distribution cost of $10 per screen. If the AD purchases screens from outside suppliers at a price of $130 per​ screen, it will incur a variable purchasing cost of $44 per screen. Shamrock​'s division managers can act autonomously to maximize their own​ division's operating income.

Requirements:

1.	What is the minimum transfer price at which the SD manager would be willing to sell screens to the​ AD?
2.	What is the maximum transfer price at which the AD manager would be willing to purchase screens from the​ SD?
3.	Now suppose that the SD can sell only 70​% of its output capacity of 20,000 screens per month on the open market. Capacity cannot be reduced in the short run. The AD can assemble and sell more than 20,000 TV sets per month.
	a.	What is the minimum transfer price at which the SD manager would be willing to sell screens to the​ AD?
	b.	From the point of view of Shamrock​'s management, how much of the SD output should be transferred to the​ AD?
	c.	If Shamrock mandates the SD and AD managers to​ "split the​ difference" on the minimum and maximum transfer prices they would be willing to negotiate​ over, what would be the resulting transfer​ price? Does this price achieve the outcome desired in requirement​ 3b?

Answer 1

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Part 1
Minimum Transfer Price		$           120
$130 Selling price-$10 Variable Marketging Cost
Part 2
Maximum Transfer price		$           134
$130 Purchase cost+$4 Variabe Pur Cost
Part 3a
Minimum Transfer Price:
For first 6,000 Units (20,000*30%)		$              90
For units above 6,000		$           120
Part 3b
From company point of view, 100% of SD output
should be transferred to AD since it will save:
Variable Markeging and Dis Cost incurred by SD		$              10
Variable Purchase Cost incurred by AD		$                4
		$              14
Part 3c
In this case, transfer pricing will be in between
$120 and $134 (From part 1 and 2).
Exact transfer pricing will depend on negotiation
strength and skill of respective department