Question

TRANSFER PRICING/ PRICING POLICIES

1.
The Glass Division of Sonnet, Inc., manufactures a variety of glasses and vases for
household use. The vases can be sold externally or internally to Sonnet’s Florist
Division. Sales and cost data on a basic ten-inch vase are given below:

Unit selling price $2.50
Unit variable cost $1.10
Unit product fixed cost* $0.50
Practical capacity in units 500,000

*$250,00/500,000

During the coming year, the Glass Division expects to sell 350,000 units of this
vase. The Florist Division currently plans to buy 150,000 vases on the outside market for
$2.50 each. Neil Harper, manager of the Glass Division, approached Martha Strahorn,
manager of the Florist Division, and offered to sell the 150,000 vases for $2.45 each.
Neil explained to Martha that he can avoid selling costs of $0.10 per vase by selling
internally and that he would split the savings by offering a $0.05 discount on the usual
price.

Required
a. What is the minimum transfer price that the Glass Division would be willing to
accept? What is the maximum transfer price that the Florist Division would be
willing to pay? Should an internal transfer take place? What would be the benefit
(or loss) to the firm as a whole if the internal transfer takes place?
b. Suppose Martha knows that the Glass Division has idle capacity. Do you think
that she would agree to the transfer price of $2.45? Suppose she counters with an
offer to pay $2.00. If you were Neil, would you be interested in this price?
Explain with supporting computations.
c. Suppose that Sonnet, Inc., policy is that all internal transfers take place at full
manufacturing cost. What would the transfer price be? Would the transfer take
place?

Answer 1