Question

Going Places, Inc., manufactures a variety of luggage for airline passengers. The company has several luggage production divisions, including the Suitable Cases Division, as well as a wholly owned subsidiary, It’s Mine, that manufactures small identification tags used on luggage. Each piece of luggage that Suitable Cases produces has two identification tags for which it previously paid the going market price of $2 each. Financial information for Suitable Cases and It’s Mine follows:
 

	Suitable Cases Division			It’s Mine
Sales
4,500 bags × $150.00 each	$	675,000
200,000 tags × $2.00 each				$	400,000
Variable expenses
4,500 bags × $85.00 each		382,500
200,000 tags × $0.50 each					100,000

It’s Mine has a production capacity of 250,000 tags.   

Required:
1. Determine how much Going Places will save on each tag if the Suitable Cases Division obtains them from It’s Mine instead of an external supplier.
2. Determine the maximum and minimum transfer prices for the tags.
3. Suppose Going Places has set a transfer price policy of variable cost plus 60 percent for all related-party transactions. Determine how much each party will benefit from the internal transfer.
4. Determine the mutually beneficial transfer price.

Answer 1

1. The Suitable Cases Division is currently paying $2.00 per tag, but It’s Mine’s variable cost is only $0.50. Therefore, Going Places could save $1.50 per tag with an internal transfer.

2. The maximum transfer price of $2 is the market price, which is the most the buyer (Suitable Cases Division) is willing to pay. The minimum transfer price is $0.50, or the minimum amount the seller (It’s Mine) would accept.

3. A policy of variable cost plus 60% would result in a transfer price of $0.80 ($0.50 × 160%). Suitable Cases Division would save $1.20 (market price of $2.00 – transfer price of $0.80), while It’s Mine would make $0.30 (transfer price of $0.80 – variable cost of $0.50).

4. A mutually beneficial price would mean the buyer and seller would share the $1.50 ($2.00 – $0.50) per unit savings. A transfer price of $1.25 would split the benefit equally. The seller would make $0.75 ($1.25 price – $0.50 variable cost), while the buying division would save $0.75 ($2.00 market price vs. $1.25 transfer price).