US Pumps is a multidivisional firm that manufactures and installs chemical piping and pump systems. Its valve division makes a single standardized valve. The valve division and installation division currently are involved in a transfer-pricing dispute. Last year, half of the valve division's output was sold to the installation division for $40 and the remaining half was sold to outsiders for $60.
The existing transfer price of $40 per pump has been set through a negotiation process between the two divisions and with the involvement of senior management. The installation division has received a bid from an outside value manufacturer to supply it with an equivalent valve for $35 each.
The valve's division's manager has argues that if it is forced to meet the external price of $35 it will l ose money on internal sales.
The operating data for the last year for the valve division follow:
Valve Division
Operating Statement-Last year
To Installation Division To Outside
Salas 20k@ $40 $800,000 20,000 @ $60
$1,200,000
Variable cost @ $30 (600,000) (600,000)
Fixed Cost (135,000) (135,000)
Gross margin $ 65,000 $465,000
Analyze the situation and recommend a course of action. What should the installation division managers do? What should the valve division managers do? In your opinion, what should the US Pumps senior manager do?