Question

Hrubec Products, Inc., operates a Pulp Division that manufactures wood pulp for use in the production of various paper goods. Revenue and costs associated with a ton of pulp follow:

  

Selling price		$20
Expenses:
Variable	$11
Fixed (based on a capacity of         104,000 tons per year)	6	17
Net operating income		$3

  

Hrubec Products has just acquired a small company that manufactures paper cartons. This company will be treated as a division of Hrubec with full profit responsibility. The newly formed Carton Division is currently purchasing 30,000 tons of pulp per year from a supplier at a cost of $20 per ton, less a 10% purchase discount. Hrubec’s president is anxious for the Carton Division to begin purchasing its pulp from the Pulp Division if an acceptable transfer price can be worked out.

  

Required:

For (1) and (2) below, assume that the Pulp Division can sell all of its pulp to outside customers for $20 per ton.

  

1-a.	What is the minimum transfer price for Carton Division?

       

1-b.	What is the maximum transfer price that Pulp Division is ready to pay? (Round your answer to 2 decimal places.)

       

1-c.	Are the managers of the Carton and Pulp Divisions likely to voluntarily agree to a transfer price for 30,000 tons of pulp next year?
	No Yes

2.	If the Pulp Division meets the price that the Carton Division is currently paying to its supplier and sells 30,000 tons of pulp to the Carton Division each year, what will be the effect on the profits of the Pulp Division, the Carton Division, and the company as a whole?

      

For (3)-(6) below, assume that the Pulp Division is currently selling only 65,000 tons of pulp each year to outside customers at the stated $20 price.

3a.	What is the minimum transfer price for Pulp Division?

        

3-b.	What is the range of transfer price the manager's of both divisions should agree? (Round your answers to 2 decimal places.)

       

3-c.	Are the managers of the Carton and Pulp Divisions likely to voluntarily agree to a transfer price for 30,000 tons of pulp next year?
	No Yes

4-a.	Suppose that the Carton Division’s outside supplier drops its price (net of the purchase discount) to only $16 per ton. Should the Pulp Division meet this price?
	Yes No

4-b.	How much potential profit will the Pulp Division lose if the $16 price is not met?

        

5.	Refer to (4) above. If the Pulp Division refuses to meet the $16 price, should the Carton Division be required to purchase from the Pulp Division at a higher price for the good of the company as a whole?
	Yes No

6.	Refer to (4) above. Assume that due to inflexible management policies, the Carton Division is required to purchase 30,000 tons of pulp each year from the Pulp Division at $20 per ton. What will be the effect on the profits of the company as a whole?

     

Answer 1

Here in Question 1a) and 1b). Division names are wrongly used, Pulp division will take the price and Carton division will pay the price.
1a). Minimum transfer price for pulp division = $20 i.e selling price because it is able to sell all its pulp to outside.

1b). Maximum transfer price which the carton division is ready to pay = $20 - 10% = $18

1c). Managers of both divisions are not likely to agree to transfer the pulp because there is no match between the minimum and maximum transfer prices of pulp division and carton division respectively.

2). If pulp division ready to accept the transfer price of $18 then there is a loss to pulp division of $60000 (30000 tons * $2 per ton). It is also a loss to the company as a whole.

Assuming pulp division is able to sell only 65000 tons of pulp to outside customers at $20.

3a). Minimum transfer price of pulp division is $11 , which is relevant cost when the capacity is vacant, here fixed cost are not considered because it incurs wheather or not there is inter divisional transfers.

3b). Range of Transfer prices is: $11 to $18. (Min. of pulp division and max. of carton division).

3c). Yes, Managers of the both the division are likely to agree to transfer pulp in next year.

4a). If price of outside supplier drops to $16, then pulp division should meet this price, because it will benefit the division and to the company as a whole.

4b). If $16 price not met by pulp division then the loss of potential profit is :
30000 tons * ($16 - $11) = $150,000

5). Yes, If pulp division not meet the $16 price, carton division should be required to purchase the pulp from pulp division for the good of company as a whole.

6). If carton division is required to puchase from pulp division at $20, then the profits of company as a whole will increase by $150,000. i,e
= profit to pulp division $9 - Loss to carton division $4= Net profit to company $5 per ton
Total profit = $5 * 30000 tons = $150,000