Question

Transfer Pricing Aulman Inc. has a number of divisions including a Furniture Division and a Motel Division. The Motel Division owns and operates a line of budget motels located along major highways. Each year, the Motel Division purchases furniture for the motel rooms. Currently, it purchases a basic dresser from an outside supplier for $50. The manager of the Furniture Division has approached the manager of the Motel Division about selling dressers to the Motel Division. The full product cost of a dresser is $29. While the Furniture Division has been operating at capacity (50,000 dressers per year) and selling them for $50 each, it expects to produce and sell only 40,000 dressers for $50 each next year. The Furniture Division incurs variable costs of $15 per dresser The Motel Division needs 10,000 dressers per year; the Furniture Division can make up to 50,000 dressers per year. The company policy is that all transfer prices are negotiated by the divisions involved. Required: 1. What is the maximum transfer price? Which division sets it? 2. What is the minimum transfer price? Which division sets it? 3. Suppose that the two divisions agree on a transfer price of $38. What is the benefit for the Furniture Division? For the Motel Division? For Aulman Inc. as a whole? Benefit to Furniture Division Benefit to Motel Division Benefit company

Answer 1

1.Maximum Transfer Price is equal to market price i.e. $50 per unit

The Motel Division sets the Maximum price

2.Since there is spare capacity, The minimum price is equal to variable cost

i.e. $15 per unit

The Transferring division sets the transfer price i.e. Furniture Division

3.Benefit to

Furniture Division = (38-15)*10,000 = $230,000

Motel = (50-38)*10,000 = $120,000

Company = $350,000

1.EVA = After Tax Income – Capital Employed*Cost of Capital

= 14,107,956 – 127,399,560*9%

= $2,641,995.6

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