Transfer Pricing
The Components Division produces a part that is used by the Goods Division. The cost of manufacturing the part follows:
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Direct materials
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$10
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Direct labor
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2
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Variable overhead
|
3
|
|
Fixed overhead*
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5
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Total cost
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$20
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*Based on a practical volume of 200,000 parts.
Other costs incurred by the Components Division are as follows: Fixed selling and administrative $500,000
Variable selling (per unit) 1
The part usually sells for between $28 and $30 in the external market. Cur- rently, the Components Division is selling it to external customers for $29. The division is capable of producing 200,000 units of the part per year; however, because of a weak economy, only 150,000 parts are expected to be sold during the coming year. The variable selling expenses are avoidable if the part is sold internally.
The Goods Division has been buying the same part from an external sup- plier for $28. It expects to use 50,000 units of the part during the coming year. The manager of the Goods Division has offered to buy 50,000 units from the Components Division for $18 per unit.
Required
1. Determine the minimum transfer price that the Components Division would accept.
2. Determine the maximum transfer price that the manager of the Goods Divi- sion would pay.
3. Should an internal transfer take place? Why or why not? If you were the man- ager of the Components Division, would you sell the 50,000 components for $18 each? Explain.
4. Suppose that the average operating assets of the Components Division total $10 million. Compute the ROI for the coming year, assuming that the 50,000 units are transferred to the Goods Division for $21 each.