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121. Meredith Motor Works has just acquired a new Battery Division. The Battery Division
produces a standard 12volt battery that it sells to retail outlets at a competitive price of $20. The
retail outlets purchase about 800,000 batteries a year. Since the Battery Division has a capacity of
1,000,000 batteries a year, top management is thinking that it might be wise for the company’s
Automotive Division to start purchasing batteries from the newly acquired Battery Division.
The Automotive Division now purchases 300,000 batteries a year from an outside supplier, at a
price of $18 per battery. The discount from the competitive $20 price is a result of the large
quantity purchased.
The Battery Division’s cost per battery is shown below:
Fixed costs are based on 1,000,000 batteries.
Both divisions are to be treated as investment centers, and their performance is to be evaluated
by the ROI formula.
Required:
a. What transfer price would you recommend and why?
b. What transfer price would you recommend if the Battery Division is now selling 1,000,000
batteries a year to retail outlets?
c. Suppose the manager of the Battery Division can increase its capacity to 1,500,000 units for
$1,200,000. She then has the option of (a) cutting the retail price to $17.50 with the certainty that
sales will increase to 1,500,000 batteries, or (b) maintaining the outside price of $20.00 for the
800,000 batteries and transferring the 300,000 batteries to the Automotive Division at some price
that would produce the same income for the Battery Division as option (a). What is the minimum
transfer price you would recommend in this situation?
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122. Metalbinders, Inc., has two divisions for its metal fabrication business. Division A stamps
the objects and then transfers them to Division B, which finishes and sells them. Last year,
Division A had administrative expenses of $40,000. Division B incurred additional production costs
of $120,000 (exclusive of amounts paid to Division A for the stamped steel) to process 120,000
units. Division B sold the finished goods for $500,000 and incurred $80,000 in variable selling and
administrative expenses.
Required:
a. Prepare income statements for each division. Use a transfer price of Division A’s total cost plus
5%. Assume Cost of Goods Sold for Division B is $351,000.
b. Repeat (a), using a transfer price of $2.00 per unit; this is also the market price.
c. Repeat (a), using a negotiated transfer price of $1.90 per unit.
d. Which transfer price results in higher income to Metalbinders, Inc.?
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123. Division S sells its product to unrelated parties at a price of $20 per unit. It incurs variable
costs of $7 per unit and has fixed costs of $50,000 per month. Monthly production is generally
10,000 units.
Division B uses Division S’s product in its operations. It can purchase the units from Division S at
$20 per unit, but must pay a $1.50 per unit in shipping costs. Alternatively, Division B can buy
from Division S’s competition at a delivered price of $21 per unit.
Required:
a. From the company’s perspective, should Division B purchase the units internally or externally?
Assume Division S has ample capacity to handle all of Division B’s needs.
b. Would your answer change if Division S can sell everything it produces to outside customers?
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124. Roberts Machinery Company manufactures heavy-duty equipment used in foundries,
mining operations, and similar operations. The company is very decentralized, with various
division managers having control over capital investments and most production decisions. The
Cylinder Division fabricates a component which is used by the Press Division in its production of
metal presses. The Cylinder Division has been selling to the Press Division at a price of $3,000 per
unit. Because of a cost increase, the Cylinder Division wants to increase its price to $3,200, even
though the Press Division can still purchase an equivalent component externally for $3,000. The
following information has been gathered regarding this issue:
Required:
a. If the Press Division buys its units externally, the Cylinder Division will have idle capacity for
which there are no alternative uses. Will the company as whole benefit if the Press Division
purchases its units externally for $3,000 per unit?
b. If the Press Division buys its units externally, the Cylinder Division will have idle capacity which
can be used to generate a positive cash flow of $40,000. Will the company as whole benefit if the
Press Division purchases its units externally for $3,000 per unit?
c. Refer to (b). Will your answer change if the price at which the Press Division can buy externally
decreases to $2,700 per unit? Support your answer.
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125. The ABC Manufacturing Company has a division (P Division) that produces an essential
ingredient used by the Lawn Division in making lawn fertilizer. Historically, 75% of Division P’s
output has been purchased by Division L and 25% has been sold to other fertilizer companies. The
transfer price between Division P and Division L has been based on the outside sales price less
selling and administrative expenses directly applicable to the outside sales. Last year, the transfer
price was $35 per ton; Division P would like the same transfer price this year. However, the
general manager of Division L has found an outside supplier who will sell the ingredient for $30
per ton. She would like to continue buying from Division P, but Division P’s manager does not
want to match the $30 price because he thinks that the margin is too small. Top management
does not get involved in transfer pricing disputes, but rather, allows division managers to make
their own decisions concerning internal or external purchases and sales.
The following information has been gathered regarding Division P’s operations last year:
The information presented above is based on selling 120,000 tons internally and 40,000 tons
externally.
Required:
a. If Division L buys externally, Division P can increase its current external sales by only 20,000
tons. What arguments can the general manager of Division L make to help Division P to match the
$30 price?
b. Division L wants to use only one supplier, so Division P will either sell 120,000 tons to Division
L or nothing. If Division L’s capacity is 160,000 tons, how many units does Division P need to sell
to outsiders at $50 per ton before it is better off selling to outsiders? Ignore any additional
marketing costs which would be incurred to increase sales.
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126. The Pump Division of Nord Co. produces pumps which it sells for $20 each to outside
customers. The pump Division’s cost per pump, based on normal volume of 500,000 units per
period, is shown below:
Nord has recently purchased a small company which makes automatic dishwashers. This new
company is presently purchasing 100,000 pumps each year from another manufacturer. Since the
Pump Division has a capacity of 600,000 pumps per year and is now selling only 500,000 pumps to
outside customers, management would like the new Dishwasher Division to begin purchasing its
pumps internally. The Dishwasher Division is now paying $20 per pump, less a 10% quantity
discount. The Pump Division could avoid $1 per unit in variable costs on any sales to the
Dishwasher Division.
Required:
a. Treating each division as an independent profit center, within what price range should the
internal sales price fall?
b. Now assume that the Pump Division is selling 600,000 pumps per year on the outside.
Determine the appropriate transfer price. Show all computations.
(Note: Due to limitations in fonts and word processing software, > and < signs must be used in
this solution rather than “greater than or equal to” and “less than or equal to” signs.)
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127. Fistman Corporation has a Parts Division that does work for other Divisions in the
company as well as for outside customers. The company’s Machine Products Division has asked
the Parts Division to provide it with 10,000 special parts each year. The special parts would
require $15.00 per unit in variable production costs.
The Machine Products Division has a bid from an outside supplier for the special parts at $29.00
per unit. In order to have time and space to produce the special part, the Parts Division would
have to cut back production of another part – the H56 that it presently is producing. The H56 sells
for $32.00 per unit, and requires $19.00 per unit in variable production costs. Packaging and
shipping costs of the H56 are $3.00 per unit. Packaging and shipping costs for the new special
part would be only $1.00 per unit. The Parts Division is now producing and selling 40,000 units of
the H56 each year. Production and sales of the H56 would drop by 20% if the new special part is
produced for the Machine Products Division.
Required:
a. What is the range of transfer prices within which both the Divisions’ profits would increase as a
result of agreeing to the transfer of 10,000 special parts per year from the Parts Division to the
Machine Products Division?
b. Is it in the best interests of Fistman Corporation for this transfer to take place? Explain.
(Note: Due to limitations in fonts and word processing software, > and < signs must be used in
this solution rather than “greater than or equal to” and “less than or equal to” signs.)
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128. Division N has asked Division M of the same company to supply it with 10,000 units of
part P782 this year to use in one of its products. Division N has received a bid from an outside
supplier for the parts at a price of $25.00 per unit. Division M has the capacity to produce 50,000
units of part P782 per year. Division M expects to sell 46,000 units of part P782 to outside
customers this year at a price of $26.00 per unit. To fill the order from Division N, Division M
would have to cut back its sales to outside customers. Division M produces part P782 at a variable
cost of $17.00 per unit. The cost of packing and shipping the parts for outside customers is $1.00
per unit. These packing and shipping costs would not have to be incurred on sales of the parts to
Division N.
Required:
a. What is the range of transfer prices within which both the Divisions’ profits would increase as a
result of agreeing to the transfer of 10,000 parts this year from Division N to Division M?
b. Is it in the best interests of the overall company for this transfer to take place? Explain.
(Note: Due to limitations in fonts and word processing software, > and < signs must be used in
this solution rather than “greater than or equal to” and “less than or equal to” signs.)
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129. Cleary Yard Equipment Corporation manufactures lawn mowers and snow blowers. It also
manufactures engines that are used by the Lawn Mower Assembly Division (LMAD). The Engine
Division (ED) also sells about 40% of its output to the outside market (these are multipurpose
engines). Its annual capacity is 150,000 units and annual output 135,000 units. All engines sold
internally to the LMAD are priced at cost plus 20% markup.
In January 2012, the Snow Blower Assembly Division (SBAD) approached the ED to ‘buy’ 20,000
engines. Diane Holinger, the controller of ED, computed the costs of manufacturing these engines
as follows:
Holinger quoted a price of $66.60 for each engine transferred to the SBAD. John Hargreaves, the
manager of SBAD, was furious to note that the ED was “trying to make money off a sister
division.” He argued that the price must include only the cost of materials, as all other costs will
be incurred irrespective of whether or not SBAD places the order for 20,000 engines. Matt Hall,
the production manager of ED, pointed out that the special equipment will be purchased only for
fulfilling this internal order. Moreover, he argued that inspection must also be done just like on all
other engines; therefore, the inspection costs must also be included. Labor is paid a flat monthly
salary. Other manufacturing costs include both variable and fixed components (in roughly equal
proportion).
Required:
(a) Given that excess capacity exists, what is the minimum price that the ED must charge to the
SBAD?
(b) What are the pros and cons of internal sourcing?
130. Division A of Friedman Inc. transfers its product to Division B. Division B can either buy
the item internally or externally (cost = $73 each). Division A has just completed its annual cost
update as follows:
Division A is operating at 60 percent of its 400,000 unit capacity.
Required:
1) What is the minimum transfer price Division A should charge for internal transfers?
2) What is the maximum price Division B would be willing to pay?
3) Why should Division A reduce its price to Division B?
131. The following costs exist for Division M of Clark Corp.
The output of Division M, which sells for $10/unit externally, is used by Division N.
Required: Compute the transfer price for a unit of Division M’s output using:
1) market price
2) variable production cost plus 30 percent
3) absorption cost plus 25 percent
4) variable cost
5) total cost plus 10 percent
132. Grupe Inc. has a division located in Spain and another in the U.S. The Spanish division
produces a part needed for the product made by the U.S. division. There is substantial excess
capacity in the Spanish division. The tax rate of the Spanish division is 35% and U.S. division tax
rate is 30%.
The part sells externally for $75 and the Spanish division’s manufacturing costs are:
Required:
1) What would be the lowest acceptable transfer price for the Spanish division?
2) What would be the highest acceptable transfer price for the U.S. division?
3) What would be the transfer price that would be the best for Grupe Inc. and why?
133. The following information is available for the two divisions of CPAECON Co.:
Division A has no excess production capacity.
Required:
1) In order to ensure the best use of the productive capacity of A, what transfer price should be
set by Division A and what effect does this transfer price have on the overall margin for the
company? Is the answer goal congruent under the general rule?
2) Should Division B accept a special order for its product if the selling price is reduced to $70.
Use your answer from #1 and explain.
3) Would your answer to #2 change if Division A had excess capacity? Explain.