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			$	21
Expenses:
Variable	$	12
Fixed (based on a capacity of 100,000 tons per year)		6		18
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 31,000 tons of pulp per year from a supplier at a cost of $21 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 the Pulp Division can sell all of its pulp to outside customers for $21 per ton.

1. What is the lowest acceptable transfer price from the perspective of the Pulp Division? What is the highest acceptable transfer price from the perspective of the Carton Division? What is the range of acceptable transfer prices (if any) between the two divisions? Are the managers of the Carton and Pulp Divisions likely to voluntarily agree to a transfer price for 31,000 tons of pulp next year?

2. If the Pulp Division meets the price that the Carton Division is currently paying to its supplier and sells 31,000 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 61,000 tons of pulp each year to outside customers at the stated $21 price.

3. What is the lowest acceptable transfer price from the perspective of the Pulp Division? What is the highest acceptable transfer price from the perspective of the Carton Division? What is the range of acceptable transfer prices (if any) between the two divisions? Are the managers of the Carton and Pulp Divisions likely to voluntarily agree to a transfer price for 31,000 tons of pulp next year?

4-a. Suppose the Carton Division’s outside supplier drops its price (net of the purchase discount) to only $17 per ton. Should the Pulp Division meet this price?

4-b. If the Pulp Division does not meet the $17 price, what will be the effect on the profits of the company as a whole?

5. Refer to (4) above. If the Pulp Division refuses to meet the $17 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?

6. Refer to (4) above. Assume that due to inflexible management policies, the Carton Division is required to purchase 31,000 tons of pulp each year from the Pulp Division at $21 per ton. What will be the effect on the profits of the company as a whole?

Answer 1

Generally Transfer price for a seller will be

Variable expenses + net operating income pulp division has been lost for not selling to outsiders

in other words variable expenses + opportunity cost

For carton division the transfer price should be the amount it is paying to outsiders after discount.

carton division purchasing price :

purchase price $21

(-)discount $ 2.1 (21*10/100)

Net purchase price $18.9

1) The lowest acceptable transfer price from the perspective of the Pulp Division is $21 as it has no idle capacity.

The highest acceptable transfer price from the perspective of the Carton Division is $18.9

The Range of acceptable Transfer price between Two divisions = $15 to $18.9

Managers may not voluntarily agree upon them because the pulp division can make profit if it sells the pulp to outsiders and the manager of carton division not willing to buy at $21 because it can get the pulp from outside supplier at $18.9.

2) The profits of the pulp division will get reduced by $65100 31000* (21-18.9)

The profits of the carton division will be remain unchanged

The profits of the company as a whole will be reduced by $65100

3) The lowest acceptable transfer price from the perspective of the Pulp Division is it's variable expense i.e. $12

The highest acceptable transfer price from the persective of the carton division is $18.9

range of acceptable transfer prices between the two divisions = $12 to $18.9

Yes , the managers of both companies may likely to voluntarily agree to the transfer price because the pulp division can offer the pulp at the price of $12.

4-a) Yes , the pulp division should meet the price of $17 per ton. since it is willing to offer the pulp to carton division at $12, the pulp division can get a profit of $5 if it meets the price of $17 .

4-b) The amount of profit the company would lost as a whole is $155000 (31000*5)

5) No, it would not benefit the company as a whole because the carton division can get the pulp at $17 per ton from outside seller.

6) If the carton division purchase 31000tons of pulp from pulp division at the price of $21 the profits of the company remain unchanged because the pulp division will be made a profit of $4 per ton and the carton division will be made loss of the same amount.