Transfer Pricing

Johnston Chemical Company manufactures a wide variety of industrial chemicals and adhesives. It pur- chases much of its raw material in bulk from other chemical companies. One chemical, T-Bar, is prepared in one of Johnston's own plants. T-Bar is shipped to other Johnston plants at a specified internal price.

The Johnston adhesive plant requires 10,000 barrels of T-Bar per month and can purchase it from an outside supplier for $150 per barrel. Johnston's T-Bar unit has a capacity of 20,000 barrels per month and is presently selling that amount to outside buyers at $165 per barrel. The difference between the T-Bar unit's price of $165 and the outside firm's T-Bar price of $150 is due to short-term pricing strategy only; the mate- rials are equivalent in quality and functionality. The T-Bar unit's selling cost is $5 per barrel, and its variable cost of manufacturing is $90 per barrel.

Required

1. From the standpoint of the company as a whole, should the adhesive unit purchase T-Bar inside or outside the firm? Show calculations to support your answer.

2. Based on your answer in requirement 1, what is T-Bar's proper transfer price?

3. How would your answer to requirements 1 and 2 change if the T-Bar unit had a capacity of 30,000 bar- rels per month?