Question

SUPRA inc. has two departments: department A and B. Department A produces cooling elements. Department B produces freezers. Department B is used to buy cooling elements with department A, but it is also possible to source cooling elements with outside suppliers. One freezer requires one cooling element.

	Dept. A Cooling elements	Dept. B Freezers
Market price (£/ unit)	31.58	50
Variable costs
direct material (£/ unit)	8	5
transfer of cooling elements (£/ unit)		30
Direct labor (£/ unit)	5	3
Indirect costs (£/ unit)	2	2
Fixed costs (£/year)	500 000	225 000
External demand (n° units)	100 000	25 000
Total capacity (n° units)	130 000	30 000
Book value investment (£)	6 625 000	1 250 000

In addition to the variable costs included in the table, dept. A incurs variable packaging costs of 5% of 31.58 (= 1.58) in case of sales to the external market. This cost is not mentioned in the table.

At present the ROI of dept. B is far below the intended target (15%). The manager of dept. B faces a real risk to miss his bonus. According to manager B this is due to the excessive transfer price charged by manager A, being 5% under the market price. According to manager A this transfer price is objective (determined by the market) and the 5% reduction can be explained by savings on packaging in case of internal delivery. Manager B, however, claims that internal deliveries need to be priced at variable cost.

Corporate management asks your advice about this situation. This advice has to include:

-whether the current transfer price induces goal congruent behavior

-whether the current transfer price implies fair rewarding

-whether the suggestion of manager B (TP = variable cost) is a solution. If not, what are possible solutions?

Answer 1

selling price	34.8
variable cost
Rawmaterial cost	11.22
Packing cost	2.7
Direct labour	4.5
Variable manufacturing overhead	6
	24.42
Contribution per case	10.38
Fixed cost in first year	8800000
Break even sales cases	Fixed cost in first year/contribution per case
break even sales cases	847784.2004
Break even sales dollar	29502890.17