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		$22
Expenses:
Variable	$13
Fixed (based on a capacity of         100,000 tons per year)	6	19
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 34,000 tons of pulp per year from a supplier at a cost of $22 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 $22 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 34,000 tons of pulp next year?
	Yes No

2.	If the Pulp Division meets the price that the Carton Division is currently paying to its supplier and sells 34,000 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 58,000 tons of pulp each year to outside customers at the stated $22 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 34,000 tons of pulp next year?
	Yes No

4-a.	Suppose that the Carton Division’s outside supplier drops its price (net of the purchase discount) to only $18 per ton. Should the Pulp Division meet this price?
	Yes No

4-b.	How much potential profit will the Pulp Division lose if the $18 price is not met?

        

5.	Refer to (4) above. If the Pulp Division refuses to meet the $18 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?
	No Yes

6.	Refer to (4) above. Assume that due to inflexible management policies, the Carton Division is required to purchase 34,000 tons of pulp each year from the Pulp Division at $22 per ton. What will be the effect on the profits of the company as a whole?

      

Answer 1

1-a. Carton is currently spending the following amount on outside purchases:

Carton division would be willing to spend upto 19.8 per ton. Any transfer price above that would encourage it to purchase the material from the outside supplier itself.

1. b

If 34,000 tons are transferred to Carton and 66,000 tons are sold in the market, the maximum transfer price that pulp would agree to would be when the pulp division is breaking even. The toal cost will be the same, 1.9 million, outside sales will be 1,452,000. The balance 448,000 would be transfers to Carton. Therefore, transfer price would be = 448,000/34,000 =13.18

1.- c

No, the managers are not likely to agree to a transfer price as the entire capacity of the pulp division can be sold to the outside customers, resulting in maximum profits for the division. However, the same price cannot be used for Carton as they would not be willing to pay a price of 22 per ton when they can get the same for 19.8 per ton.

2.

3.-a

Total units produced = 58,000 + 34,000 = 92,000

Variable expenses = 1,196,000(92,000*13)

Fixed expenses = 600,000 (regardless of production)

Total expenses = 1,796,000

Sales to outside customers = 58,000 * 22 = 1,276,000

Sales/transfer required to breakeven = 1,796,000 - 1,276,000 = 520,000

Minimum transfer price = 520,000/34,000 = 15 per ton

3-b. The transfer price range that both the managers should agree upon would be 15-19.8 as 15 is the minimum price that Pulp division must transfer at and 19.8 is the maximum price that the Carton division would be willing to pay.

3-c. Yes, they are likely to voluntarily agreed on a transfer price. As the full capacity of 100,000 is not being used by the pulp division, there is no question of an opportunity loss being incurred of not selling to outisde customers.

4-a.

Yes, the pulp division should meet the price of 18 per ton. It is within the range specified in 3-b.

4-b

5. No, the division is not required to purchase from the pulp division. When the profits of the company has a whole are calculated, transfers between departments are excluded. Therefore, although the same will increase the profits of the pulp division, it will increase the costs for the carton division.

6.