Question - Transfer Pricing
MuniCorp is a decentralized company that rewards division managers based on ROI. The City Division produces a component that is used by the County Division. City's unit cost of manufacturing 5,000 components (capacity) is:
Variable costs $13
Fixed overhead $10
Total costs $23
City can sell 4,000 units on the open market for $30 by incurring selling costs of $2 per unit.
An outside supplier has offered County 5,000 units of this same component for $29. Orders of less than 5,000 units would cost the County Division $31 each. County needs the 5,000 components to make finished goods, which provide a total contribution of $245,000 excluding the cost of the component. The County Division's manager has approached the City Division manager with an offer to purchase the entire 5,000 units from the City Division for a total cost of $130,000 ($26 per unit). If this internal transaction is completed, the City Division would not incur the $2 unit selling costs.
Is the City Division better off by accepting the offer to sell 5,000 units internally for $26 each?
How much is the corporation as a whole better or worse off if the transaction is completed internally as opposed to each division dealing externally? Justify your answer.
What is the highest price the County Division would consider paying the City Division for the component?
How does the analysis change if City can sell 5,000 units on the open market for $30 with the $2 selling cost?