Transfer Pricing: Various Computations Corning Company has a decentralized organ

Question

Transfer Pricing: Various Computations Corning Company has a decentralized organization with a divisional structure. Two of these divisions are the Appliance Division and the Manufactured Housing Division. Each divisional manager is evaluated on the basis of ROI. The Appliance Division produces a small automatic dishwasher that the Manufactured Housing Division can use in one of its models. Appliance can produce up to 24,000 of these dishwashers per year. The variable costs of manufacturing the dishwashers are $96. The Manufactured Housing Division inserts the dishwasher into the model house and then sells the manufactured house to outside customers for $74,500 each. The division's capacity is 4,800 units. The variable costs of the manufactured house (in addition to the cost of the dishwasher itself) are $43,700. Required: Assume each part is independent, unless otherwise indicated. 1. Assume that all of the dishwashers produced can be sold to external customers for $314 each. The Manufactured Housing Division wants to buy 4,800 dishwashers per year. What should the transfer price be? $ per unit 2. Refer to Requirement 1. Assume $18 of avoidable distribution costs. Identify the maximum and minimum transfer prices. Maximum $ per unit Minimum $ per unit Identify the actual transfer price, assuming that negotiation splits the difference. $ per unit 3. Assume that the Appliance Division is operating at 75 percent capacity. The Manufactured Housing Division is currently buying 4,800 dishwashers from an outside supplier for $280 each. Assume that any joint benefit will be split evenly between the two divisions. What is the expected transfer price? $ per unit How much will the profits of the Appliance Division increase, assuming that it sells the extra 4,800 dishwashers internally? $ How much will the profits of the firm increase under this arrangement? $

Explanation / Answer

Answer to Part 1

Transfer price (TP) shall be the market price i.e. $ 314 as Appliance Division (AD) can sell its entire unit in the outside market.

Answer to Part 2

Maximum TP would be market price i.e. $ 314 where as minimum can be arrived at by reducing avoidable distribution cost of $ 18, thus amount shall be $ 296. If negotiation split the difference of $18 than actual TP would be $ 305.

Answer to Part 3

In case of spare capacity of 6000 units, AD can transfer at its variable cost also. Thus minimum TP would be $ 96 and maximum TP would be $ 280, price at which dishwasher is available at in the external market to HMD.

Joint benefit will be of $ 280- $ 96 = $ 184. Splitting it into two i.e. $92 each would render TP of $ 188.

Profit of AD will increase by $ 92 per unit totaling $ 441600 as it would not have been able to sell the same in the external market.

With this internal management, firms overall profit will increase by $92 in AMD division and $ 92 in AD. Thus totaling ($92+$92) x 480 = $ 883200.

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