Question

sier pricing policy and gives divisions Se prices. Can you predict what transfer price the manager of the Components Division will set? What should be the minimum transfer price for this part The maximum transfer price? Given the new transfer pricing policy. predict how this will affect the production decision Model TAC of the manager of the Small AC Division How many units of Part 4CM will the manager of the Small AC Division purchase, either internally or externally! Given the new transfer price set by the Components Division and your answer to Require went 3. how many units of 4CM will be sold externally? 4 Given ОВ blem 10.29 Transfer Pricing with Idle Capacity Inc., owns a number of food service companies. Two divisions are the Collee Dive and the Donut Shop Division. The Coffee Division purchases and roasts coffee beans For sale to supermarkets and specialty shops. The Donut Shop Division operates a chain of al shops where the donuts are made on the premises. Coffee is an important item for sale Tone with the donuts and, to date, has been purchased from the Coffee Division. Company policy permits each manager the freedom to decide whether or not to buy or sell internally. Fach divisional manager is evaluated on the basis of return on investment and residual income. . Hoween Trem Recently, an outside supplier has offered to sell coffee beans, roasted and ground, to the Donut Shop Division for $4.30 per pound. Since the current price paid to the Collee Divi- sion is $4.75 per pound, Ashleigh Tremont, the manager of the Donut Shop Division, was interested in the offer. However, before making the decision to switch to the outside sup- plier, she decided to approach Santigui Melendez, mananer of the Coffee Division, to see if he wanted to offer an even better price. If not, then Ashleigh would buy from the outside supplier. Upon receiving the information from Ashleigh about the outside offer, Santigui gathered the following information about the coffee: decided Direct materials Direct labor Variable overhead Fixed overhead* Total unit cost $0.95 0.45 0.72 1.53 $3.65 *Fixed overhead is based on S1,530,000/1,000,000 pounds. Selling price per pound Production capacity Internal sales $4.75 1,000,000 pounds 100,000 pounds Required: 1. Suppose that the Coffee Division is producing at capacity and can sell all that it produces to vulside customers. How should Santigui respond to Ashleigh's request for a lower transfer

Answer 1

Answer 1:

If the coffee division is producing at capacity and has sufficient demand outside, then it will not go to make any special consideration for Ashleigh, since it will reduce the selling price/profits of the coffee division.

Further since Ashleigh would be able to purchase the coffee from outside for Donut Division at a better price of $4.3 per pound as compared to $4.75, it would yield better profits for the Donut division.

Decision: No reduction in transfer price would be made.

Impact:

Coffee division profits remain unchanged.

The profits for Donut Division would increase to the tune of coffee purchased (100,000 pounds) externally @$0.45 ($4.75-$4.30) per pound of coffee beans purchased. Increase in profits = 100,000 x 0.45 = $45,000

Answer 2:

This decision from Coffee division will result in loss of profit for the coffee division to the tune of contribution from 100,000 pounds of coffee. While computing loss of contribution we ignore the allocated fixed costs per pound of coffee since it is irrelevant.

Loss for Coffee Division

	Coffee Div per pound	Coffee Div 100000 pound
Direct marerials	0.95	95000
Direct Labour	0.45	45000
Variable overhead	0.72	72000
Fixed Overhead
Total Variable costs	2.12	212000
Selling price	4.75	475000
Contribution	2.63	263000

Profit for Donut Division: 100,000 x 0.45 = $45,000 (as computed in Requirement 1)

Total impact on profits on firm as a whole = ($263,000) + $45,000 = ($218,000)

i.e. Loss of $218,000

Answer 3

As computed in Requirement 2, the minimum transfer price would be the Total variable cost for the coffee division = $2.12/pound

The maximum transfer price would be the selling price as fetched in market = $4.75/pound

New transfer price set = $4.75 - $1 = $3.75

This would be acceptable to both. Acceptable to the coffee division since it is more than the variable cost and acceptable to the Donut Division since the price is even better than the price offered externally.

Effect on Profit for Coffee Division = Reduction of profits 100,000 pound x $1/pound = ($100,000)

Effect on Profit for Donut Division = Increase in Profits 100,000 pound x $1/pound = $100,000

Net impact on firms profit = ($100,000) + $100,0000 = NIL

Answer 4

Formula		Before	Now
a	Pounds sold externally	850000	850000
b	Contribution/pound from External sales	2.63	2.63
c	Pounds sold internally	100000	100000
d	Contribution/pound from Internal sales	2.63	1.63
e	Fixed cost	1530000	1530000
f=a*b+c*d-e	Profits	968500	868500
g	Operating assets	2000000	2000000
h=f/g*100	Divisional ROI%	48.425	43.425

The ROI would decrease by 5% for $1 decrease in transfer price.

Information gained: ROI sensitvity to decrease in transfer price.