Question :

Transfer pricing, ethics, goal congruence. Jeremiah Industries manufactures high-grade aluminum luggage made from recycled metal. The company operates two divisions: metal recycling and luggage fabrication. Every division operates as a decentralized entity. The metal recycling division is free to sell sheet aluminum to outside buyers, and the luggage fabrication division is free to buy recycled sheet aluminum from other sources. Presently, thus, the recycling division sells all of its output to the fabrication division, and the fabrication division does not purchase materials from any external suppliers. Aluminum is transferred from the recycling distribution to the fabrication division at 110% of full cost. The recycling division buys recyclable aluminum for $0.50 per pound. The division's other variable costs equivalent $2.80 per pound, and fixed costs at a monthly production level of 50,000 pounds are $1.50 per pound. In the most recent month, 50,000 pounds of aluminum were transferred between the two divisions. The recycling division's capacity is 70,000 pounds. Because of increased demand, the fabrication division expects to use 60,000 pounds of aluminum next month. Metalife Corporation has offered to sell 10,000 pounds of recycled aluminum subsequently month to the fabrication division for $5.00 per pound.

Required

1. Determine the transfer price per pound of recycled aluminum. Consider that each division is considered a profit center; could the fabrication manager decide to purchase 10,000 pounds next month from Metalife?

2. Is the purchase in the best interest of Jeremiah Industries? Evaluate the cause of this goal incongruence?

3. The fabrication division manager suggests that $5.00 is now the market price for recycled sheet aluminum, and that this should be the new transfer price. Jeremiah's corporate management leads to agree. The metal recycling manager is suspicious. Metalife's prices have always been significantly higher than $5.00 per pound. Why the sudden price cut? After further investigation by the recycling division manager, it is revealed that the $5.00 per pound price was a one-time-only proposes made to the fabrication division due to excess inventory at Metalife. Future orders would be priced at $5.50 per pound. Comment on the validity of the $5.00 per pound market price and the principles of the fabrication manager. Would changing the transfer price to $5.00 matter to Jeremiah Industries?