Question

Hrubec Products, Inc., operates a Pulp Division that manufactures wood pulp for use in the production of various paper goods. Revenue and costs associated with a ton of pulp follow: $21 $11 Selling price Expenses: Variable Fixed (based on a capacity of 95,000 tons per year) Net operating income 6 17 Hrubec Products has just acquired a small company that manufactures paper cartons. This company will be treated as a division of Hrubec with full profit responsibility. The newly formed Carton Division is currently purchasing 31,000 tons of pulp per year from a supplier at a cost of $21 per ton, less a 10% purchase discount. Hrubec's president is anxious for the Carton Division to begin purchasing its pulp from the Pulp Division if an acceptable transfer price can be worked out. Required: For (1) and (2) below, assume the Pulp Division can sell all of its pulp to outside customers for $21 per ton. 1. What is the lowest acceptable transfer price from the perspective of the Pulp Division? What is the highest acceptable transfer price from the perspective of the Carton Division? What is the range of acceptable transfer prices (if any) between the two divisions? Are the managers of the Carton and Pulp Divisions likely to voluntarily agree to a transfer price for 31,000 tons of pulp next year? 2. If the Pulp Division meets the price that the Carton Division is currently paying to its supplier and sells 31,000 tons of pulp to the Carton Division each year, what will be the effect on the profits of the Pulp Division, the Carton Division, and the company as a whole? For (3)–(6) below, assume that the Pulp Division is currently selling only 56,000 tons of pulp each year to outside customers at the stated $21 price. 3. What is the lowest acceptable transfer price from the perspective of the Pulp Division? What is the highest acceptable transfer price from the perspective of the Carton Division? What is the range of acceptable transfer prices (if any) between the two divisions? Are the managers of the Carton and Pulp Divisions likely to voluntarily agree to a transfer price for 31,000 tons of pulp next year? 4-a. Suppose the Carton Division's outside supplier drops its price (net of the purchase discount) to only $16 per ton. Should the Pulp Division meet this price? 4-b. If the Pulp Division does not meet the $16 price, what will be the effect on the profits of the company as a whole? 5. Refer to (4) above. If the Pulp Division refuses to meet the $16 price, should the Carton Division be required to purchase from the Pulp Division at a higher price for the good of the company as a whole? 6. Refer to (4) above. Assume that due to inflexible management policies, the Carton Division is required to purchase 31,000 tons of pulp each year from the Pulp Division at $21 per ton. What will be the effect on the profits of the company as a whole?

Answer 1

1-a

The lowest transfer price for Carton division would be $18.9 per ton ($21 – 10%). The carton division would not pay more than $18.90 per ton.

The lowest transfer price for Pulp division would be $21 per ton i.e the amount that pulp division is receiving from outsiders. In the given case pulp division has no idle capacity. Therefore not sacrifice profits.

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1-b

The maximum price that the pulp division would be ready to pay is $17 per ton (Fixed + variable) incurred per unit.

The maximum transfer price that the carton division would be ready to pay is $18.90 i.e. the price that the carton division is paying to the outside supplier. The carton division would not be ready to pay more than $18.90 per ton.

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1-c

No, the managers of the carton and pulp division could not voluntarily agree to transfer price for 31,000 tons of pulp next year because the pulp division has no idle capacity. Therefore, the pulp division would not sell below $21 per ton and the carton division would not pay more than $18.90 per ton. Hence, they would not agree to a price range.

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2.

The profit of the pulp division would be decreased by $65,100 [31,000 × ($21 - $18.90)]. The profit of the carton division would remain unaffected as it is paying the same price. Therefore, the profit of the company would also decrease by $65,100.