Question - Transfer pricing and outside opportunities
Deseronto Electronics manufactures motherboards for computers. The company is divided into two divisions: manufacturing and programming. The manufacturing division makes the board, and the programming division makes the adjustments required to meet the customer's specifications. The average total cost per unit of the boards in the manufacturing division is about $450, and the average total cost per board incurred in the programming division is about $100. The average selling price of the boards is $700. The company is now operating at capacity, and increasing the volume of production is not a feasible alternative. In the past, the managers of the two divisions have negotiated a transfer price. The average transfer price has been about $500, resulting in the manufacturing division recognizing a profit of about $50 per board and the programming division recognizing a profit of about $100 per board. Each of the managers receives a bonus that is proportional to the profit reported by his or her division. Karen Barton, the manager of the manufacturing division, has announced that she is no longer willing to supply boards to the programming division. Sam Draper, the senior purchasing executive for Koala Electronics, a computer manufacturer, has indicated that he is willing to purchase, at $650 per unit, all the boards that karen's division can supply and is willing to sign a long-term contract to that effect. Karen indicated that she offered the boards to the programming division at $625 per board on the grounds that selling and distribution costs would be reduced by selling inside. Neil Wilson, the manager of the programming division, refused the offer on the grounds that the programming division would show a loss at this transfer price. Neil has appealed to Shannon McDougald, the general manager, arguing that Karen should be prohibited from selling outside. Neil has indicated that a preliminary investigation suggets that he cannot buy these boards for less than about $640 outside. Therefore, allowing Karen to sell outside would effectively doom Neil's division.
Required -
a. What transfer price would you recommend? Why?
b. What recommendations do you have for the programming division?