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	$	11
Fixed (based on a capacity of 96,000 tons per year)		6		17
Net operating income			$	4

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 29,000 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 29,000 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 29,000 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 57,000 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 29,000 tons of pulp next year?

4-a. Suppose the Carton Division’s outside supplier drops its price (net of the purchase discount) to only $16 per ton. Should the Pulp Division meet this price?

4-b. If the Pulp Division does not meet the $16 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 $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?

6. Refer to (4) above. Assume that due to inflexible management policies, the Carton Division is required to purchase 29,000 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

Solution 1
Lowest Acceptable tranfer price by pulp division	21	(Selling price to Outside customers)
Highest Acceptable tranfer price by carton division	18.90	(Purchases price paid to ouside supplier net of discount)
There is not a range of acceptable transfer Prices	No range
Will the managers agree to a tranfer price?	No
Solution 2:
Profits of Pulp division will decrease by	60900	[29000*(21-$18.90)]
Profits of Carton division will remain unchanged by	0
Profits of the company as whole will decrease by	60900	[29000*(21-$18.90)]
Solution 3
Lowest Acceptable tranfer price by pulp division	11	(variable cost per unit)
Highest Acceptable tranfer price by carton division	18.90	(Purchases price paid to ouside supplier net of discount)
There is a range of acceptable transfer Prices	11 to 18.90
Will the managers agree to a tranfer price?	Yes
Solution 4:
Should the Pulp Division meet this price?	Yes	(Because the price is still higher than variable cost to Pulp division)
Profits of the company as whole will decrease by	145000	[29000*(16-$11)]
Solution 5:
Yes, The carton division can accept a higher price for the good of the company as a whole.
Solution 6:
Profits of Pulp division will Increase by (a)	290000	[29000*(21-$11)]
Profits of Carton division will Decrease by (b)	145000	[29000*(21-$16)]
The company as whole will an increase in profits by	145000	(a- b)