Question

Cost Management: A Strategic Emphasis (8th Edition) Chapter 19, Problem 49

Transfer Pricing;

Decision Making Phoenix Inc., a cellular communication company, has multiple business units, organized as 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 will 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%; the division can operate at 100%
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 externally, not internally 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 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?

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.

Answer 1