Question

Transfer Pricing with Opportunity Cost Case Study The Lawnman Corporation, the manufacturer of Fasvrider lawnmowers is a highly decentralized company. Each division manager has full authority for sourcine decisions. The Engine Division of wirion produces the engine for the lawnmower and the Assembly Division produces the lawnmower. There is or There is a market for the engine as well as the lawnmower. Each of the divisions has been designated as a profit center. The transfer price for the engine has been set at the long run average market price. The following data are available for each division. 1 0 The Engine Division: Selling (market) price for the engine 700 Incremental cost per unit in the Engine Division The Assembly Division: Selling price of the lawnmower Incremental cost per unit in Assembly Division 480 $1,200 600 The Engine Division has a capacity to produce 10,000 units of the engine per year. a. Assuming that there is no excess capacity in the Engine Division, what will be the minimum transfer price that the Engine Division will accept and the maximum transfer price that the Assembly Division will accept? b. Assuming that the Engine Division is producing and selling only 9,000 units of the engines, what would be the minimum transfer price per unit for the Engine Division and the maximum transfer price for the Assembly Division for 1,000 units? C. Assuming that the Engine Division is producing and selling only 9,000 units of the engines and that 1,000 additional engines were produced and transferred to the Assembly Division for the manufacture of lawnmowers. What will the impact be on the company's operating income? d. Assume that the Assembly Division can buy the 1,000 engines from an outside source for $500 pe engine. Engine Division is producing and selling only 9,000 units. What would be the minimum transfer price per unit for the Engine Division and the maximum transfer price for the Assembly Division for 1,000 units? e. Assume that the Assembly Division can buy the 1,000 engines from an outside source for $500 engine. Engine Division is producing and selling only 9,000 units and that instead of producing the 1,000 engines for the Assembly Division, the equipment and facilities could be used for other production operations that would result in an annual cash-operating savings of $50,000. What be the impact on company earnings if the Assembly Division purchased the engines from an out source instead of the Engine Division?

Answer 1

Solution:

1. With no excess capacity

       The minimum transfer price that the engine division will accept is - $700

       The maximum Transfer price that Assembly Division will accept is - $600

Hence no transfer is possible.

2. With excess capacity of 1000 units

       The minimum transfer price that the engine division will accept is - $480

       The maximum Transfer price that Assembly Division will accept is - $600

3. Impact on Company’s Operating Income

There would be an increase in the overall income to the tune of 1000(600-480) = 1000*120=$12000

4. With an outside source available for Assembly Department @500 per engine

       The minimum transfer price that the engine division will accept is - $480

       The maximum Transfer price that Assembly Division will accept is - $500

5. When Assembly department opts to purchase 1000 units @ 500 each from an outside source, it will end up contributing [1000*($600 - $500)] $10,000 to the company earnings