Joanna Wu manages the University Lab Testing department within the University Hospital....

Joanna Wu manages the University Lab Testing department within the University Hospital. Lab Testing, a profit center, performs most of the standard medical tests (such as blood tests) for other university clinical care units as well as for outside health care providers (independent hospitals, clinics, and physician groups). These outside health care providers are charged a price for each lab test using a predetermined rate schedule. University Hospital health care providers reimburse University Lab Testing using a transfer price formula. Roughly 70 percent of all Lab Testing procedures are performed for University Hospital units and the remainder for outside health care providers. Other lab testing firms in the community perform many of the same tests as Lab Testing. Lab Testing operates at about 85 percent capacity, on average. But when Lab Testing is operating at 100 percent of capacity it must refuse outside work and even sends some inside- (University Hospital-) generated specimens to other community testing labs.

A standard blood test (code Q796) performed by Lab Testing has the following cost structure:

The predetermined rate paid by the outsiders (non-University Hospital health care providers) for this test (Q796) is $68.90.

Required:

a. Suppose Lab Testing has excess capacity. What transfer price maximizes University Hospital’s profits?

b. Using the transfer price you chose in part (a), how much profit does Joanna Wu generate for her department if she performs one more Q796 test for an internal University Hospital user?

c. Suppose Lab Testing has no excess capacity. What transfer price maximizes University Hospital’s profits?

d. Using the transfer price you chose in part (c), how much profit does Joanna Wu generate for her department if she performs one more Q796 test for an internal University Hospital user?

e. What transfer pricing policy should University Hospital implement regarding other University Hospital clinical care units reimbursing Lab Testing for Q796 blood tests? Be sure to describe the logic (and any administrative problems that you considered) underlying your proposed transfer pricing policy for Q796.