Question

Cable & Wireless Inc. a multidivisional telecommunications corporation has two completely independent profit centers considering a transfer. Cable & Wireless Inc.subsidiaries operate within a decentralized environment. Cable & Wireless Inc.will not dictate transfers or impose a transfer pricing policy on the divisions. They must be free to decide whether they should transfer, and if so, they must negotiate a transfer price. Further, the Cable & Wireless Inc.reward system must be based on the total divisional profits reported by the profit centers.

One of Cable & Wireless Inc. divisions; Lime Dominica, produces telephone sets that it sells for $30 each. The standard absorptive manufacturing cost is $24, which includes $6 per unit in fixed overhead. The fixed overhead is allocated over its annual sales forecast of 50,000 telephone sets its maximum production capacity is 75,000, sets annually.

Another division, Lime Barbados, can use the telephone sets in an answering machine-telephone-radio product it markets As an alternative to buying telephone sets from Lime Dominica, Lime Barbadoscan enter into a contract for the 20,000 sets needed from a Trinidadian company, Rogers Inc. Rogers Inc. has quoted a price of $25 per set for the same quality telephone.

Required

Consider the following independent situations

a.      Determine whether a transfer should take place between Lime Dominica and Lime Barbados and the minimum and maximum transfer prices.[5 marks]

b.       Assume that Lime Barbados wants its name imprinted on the telephone set. Its Trinidadian supplier has quoted a price of $31.00 per set. Lime Dominica will have to buy a stamping machine at a net cost of $20,000.

Determine whether there should now be a transfer.

What transfer price will result in the managers benefiting equally from the transfer?

Determine the operating income for both divisions using the transfer price calculated

[7 marks]

c.       As an alternative to the two previous positions, the Lime Barbados marketing staff has decided against imprinting its name on the phone. However, they believe that if the color is changed to fuchsia, 30,000 specialty phone-answering machine-radios can be sold in the Caribbean. The Trinidadian supplier has quoted a price of $26.50 for an order of this size due to the higher cost of fuchsia. Lime Dominica already produces fuchsia-colored phones for its local market and will incur no extra costs in changing the color.Calculate whether this transfer should occur. If so, what transfer price will share the differential profits equally between the two managers?[7 marks]

d.       Compare and contrast each of the three methods used to determine a transfer price.   [6 marks]

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Answer 1

Maximum capacity of Lime Dominica is 75000 sets.
Annual sales forecast is 50000 sets.
Vacant capacity 25000 sets.

a).Here another division Lime Barbados also requires those type of telephone sets for which outside supplier quoted a price of $25 per unit. It is clear that Lime Dominica has vacant capacity which can be used to transfer 20000 units of telephone sets to Lime Barbados. Relevant cost for Lime dominica is $24 - $6 (sunk Cost) = $18 per set.
Here the transfer should be done.
Minimum transfer price = $18 form Lime Domica point
Maximum transfer pric = $24 form Lime Barbados point

b). If Lime barbados want to imprint its name on the telephone sets. for which Lime dominica will have to buy a stamping machine of $20000, which it will increase its product cost by $1. Now relevant price is $19 per set.
It is still beneficial to make the transfer happen because its price can be low then the outside suppliers price of $31 per set.
Transfer price for benefitting both divisions equally : is $25 per set. At this price there is benefit of $6 (25-19) per set to Lime dominica and benefit of $6 (31-25) per set to Lime barbados.
Operating profit from transfers to :
Lime Dominica = $6 * 20000 units = $120000
Lime Barbados = $6 * 20000 units = $120000

c). If Lime barbados wants to change the colour of instruments for which outside suppliers quoted a price of $26.50 per set.While Lime dominica already making that colour of telephone sets as not required to incur additional cost. Then the dicision remains same that there should be transfers because the price of internal transfers can be still low because the relevant cost of producting the product is still $18 which is also the minimum transfer price.
Transfer price at which both divisions share profits equally is $22.25. At this price there is a profit of $4.25 (22.25-18) per set to lime dominica division and $4.25 (26.5 - 22.25) per set to lime barbados ,