Transfer Pricing; Decision Making Phoenix Inc., a cellular communication company, has multiple divisions. Each division's management is compensated based on the division's operating income. Division A currently purchases cellular equipment from outside markets and uses it to produce communication systems. Division B produces similar cellular equipment that it sells to outside customers but not to division A at this time. Division A's manager approaches division B's manager with a proposal to buy the equipment from division B. If it produces the cellular equipment that division A desires, division B would incur variable manufacturing costs of $60 per unit.
Relevant Information about Division B
Sells 50,000 units of equipment to outside customers at $130 per unit.
Operating capacity is currently 80 percent; the division can operate at 100 percent. Variable manufacturing costs are $70 per unit.
Variable marketing costs are $8 per unit. Fixed manufacturing costs are $580,000.
Income per Unit for Division A (assuming parts purchased outside, not from division B)
|
Sales revenue Manufacturing costs:
Cellular equipment
|
80
|
$320
|
|
Other materials
|
10
|
|
|
Fixed costs
|
40
|
|
|
Total manufacturing costs
|
|
130
|
|
Gross margin Marketing costs: Variable
|
35
|
190
|
|
Fixed
|
15
|
|
|
Total marketing costs
|
|
50
|
|
Operating income per unit
|
|
$140
|
Required
1. Division A wants to buy all 25,000 units from division B at $75 per unit. Should division B accept or reject the proposal? How would your answer differ if (a) Division A requires all 25,000 units in the order to be shipped by the same supplier, or (b) Division A would accept partial shipment from Division B?
2. What is the range of transfer prices over which the divisional managers might negotiate a final transfer price? Provide a rationale for the range you provide.