Question

Adler Industries is a vertically integrated firm with several divisions that operate as decentralized profit centres. Adler's System Division manufactures scientific instruments and uses the products of two of Adler's other divisions. The Board Division manufactures printed circuit boards (PCBs). One PCB model is made exclusively for the Systems Division using proprietary designs, while less complex models are sold in outside markets. The products of the Transistor Division are sold in a well-developed competitive market; however, one transistor model is also used by the Systems Division. The costs per unit of the products used by the systems Division are presented below: Direct materials Direct labour Variable overhead Fixed overhead Total cost PCB $2.50 4.50 2.00 0.80 $9.80 Transistor $0.80 1.00 0.50 0.75 $3.05 The Board Division sells its commercial products at full cost plus a 25% markup and believes the proprietary board made for the Systems Division would sell for $12.25 per unit on the open market. The market price of the transistor used by the Systems Division is $3.70 per unit. The Board and Systems Divisions have negotiated a transfer price of $11.00 per printed circuit board. This price will: O Cause the Board Division to reduce the number of commercial printed circuit boards it manufactures Motivate both divisions as estimated profits are shared O Encourage the Systems Division to seek an outside source for printed circuit boards Demotivate the Board Division causing mediocre performance

Answer 1

Determination of range of negotiation,

1. Minimum transfer price would be the actual cost incurred by the board division that is $9.80
2. Maximum transfer price would be the current market price at which board division will be able to sell the product to open market that is $12.25

Therefore range of negotiation is 9.8 to 12.25

Actual transfer price is fixed at 11, which is exactly in the middle of the range of negotiation. this will motivate both the divisions as estimated profits are shared.

Board division won't decrease the number of PCB's it manufactures because it is getting more than the cost of 9.8 (that is 11). Systems divisions won't seek and outside supplier because the outside market price is more than what system division is getting from board division(12.25 > 11). Board division will not be demotivated because it is contributing to the overall company benefit, by foregoing small amount of margin.