Question

Transfer pricing company is a two division firm, consisting of a manufacturing division and a distribution division. Manufacturing division produces a single product, called product X. The cost of producing product X consists of a variable cost of $50 per unit, and a fixed cost of $100 per unit. This fixed cost per unit is calculated assuming that Manufacturing runs at its capacity of 10,000 units. Assume there is an external customer that contracts with Manufacturing to buy up to 4,000 units of product X for $200 per unit. More precisely, assume that the external customer will pay $200 per unit for any number of units that Manufacturing ships to it, up to 4,000 units, but it will not buy more than 4,000 units.

Q1. The distribution division wants 8,000 units of product X from the manufacturing division. Calculate the transfer price for the internal transfer of 8,000 units of product X according to the general transfer pricing rule.

Q2. The distribution division wants 10,000 units of product X from the manufacturing division. Calculate the transfer price for the internal transfer of 10,000 units of product X according to the general transfer pricing rule.

Q3. Compute the payback period of a project that requires an initial investment of $500,000 in year zero and pays back $100,000, $300,000, $400,000, and $200,000 in years 1 through 4.

Q4. Compute the discounted payback period of a project that requires an initial investment of $500,000 in year zero and pays back $100,000, $300,000, $400,000, and $200,000 in years 1 through 4. Assume that 10% is the appropriate discount rate of the project

Please show me how to get the answers.

Answer 1

1)Since the demand is more than the capacity of manufacturing division (8000+4000=12000 units) there will be a loss on regular sales of 2000 unit sales if supply is made to distribution division

Contribution on regular sales : 2000[200-50 ] = 300000

contribution on regular sales	300000
Variable cost of manufacturing [50*8000]	400000
Total cost	700000
Transfer price [700000/8000]	$ 87.5 per unit

**Fixed cost is irrelevant as it remain same within relevant range

2)

contribution on regular sales [4000*(200-50)]	600000
Variable cost of manufacturing [50*10000]	500000
Total cost	1100000
Transactionprice [1100000/10000]	$ 110

3)

year	cash Flow	cummulative cash flow
0	-500000	-500000
1	100000	-500000+100000=-400000
2	300000	-400000+300000= -100000
3	400000	-100000+400000=300000
4	200000

Payback period = period up to which cummulative cash flow is negative +[cummulative cash flow of that period /cash flow of next period]

      2+[100000/400000]

    2 + .25

   2.25 years

4)

year	cash flow	PVF 10%	Discounted cash flow [CF*PVF]	CUmmulative cash flow
0	-500000	1	-500000	-500000
1	100000	.90909	90909	-500000+90909=-409091
2	300000	.82645	247935	-409091+247935= -161156
3	400000	.75131	300524	-161156+300524= 139368
4	200000	.68301	136602

Discounted payback = 2+[161156/300524]

    2 + .54

2.54 years