Pricing Policies/Transfer Pricing Discussion 1. Brown’s Wheels makes wheels for a variety of toys and sport equipment. It sells the wheels to manufacturers that assemble and sell the toy or equipment. The company’s market research department has discovered a market for in-line skate wheels, which it presently does not produce. The market research department has indicated that a set of four wheels for in-line skates would likely sell for $6. Assume that Brown’s desires an operating profit of 20 percent. Required What is the highest acceptable manufacturing cost for which Brown’s would be willing to produce the sets of wheels? 2. Durham Industries makes high-pressure lines for a variety of heavy road improvement equipment. It sells the lines to companies that manufacture and sell the equipment. The company’s market research department has discovered a market for high-pressure lines used in automated manufacturing equipment, which Durham presently does not produce. The market research department has indicated that these lines will likely sell for $11 a foot. Required Assume that Durham desires a 10 percent operating profit. What is the highest acceptable manufacturing cost for which Durham would be willing to produce the lines? 3. Marklee Industries makes electric motors for a variety of small appliances. It sells the motors to manufacturers that assemble and sell the appliances. The company’s market research department has discovered a market for electric motors used for trolling in small fishing boats, which Marklee presently does not produce. The market research department has indicated that motors likely would sell for $46 each. A similar motor currently being produced has the following manufacturing costs: Direct materials $24 Direct labor 10 Overhead 8 Total $42 Assume that Marklee desires an operating profit margin of 10 percent. a. Suppose that Marklee uses cost-plus pricing, setting the price 10 percent above the manufacturing cost. What price should it charge for the motor? b. Suppose that Marklee uses target costing. What price should it charge for a trolling motor? What is the highest acceptable manufacturing cost for which Marklee would be willing to produce the motor? c. Would you produce such a motor if you were a manager at Marklee? Explain. 4. The Glass Division of Sonnet, Inc., manufactures a variety of glasses and vases for household use. The vases can be sold externally or internally to Sonnet’s Florist Division. Sales and cost data on a basic ten-inch vase are given below: Unit selling price $2.50 Unit variable cost $1.10 Unit product fixed cost* $0.50 Practical capacity in units 500,000 *$250,00/500,000 During the coming year, the Glass Division expects to sell 350,000 units of this vase. The Florist Division currently plans to buy 150,000 vases on the outside market for $2.50 each. Neil Harper, manager of the Glass Division, approached Martha Strahorn, manager of the Florist Division, and offered to sell the 150,000 vases for $2.45 each. Neil explained to Martha that he can avoid selling costs of $0.10 per vase by selling internally and that he would split the savings by offering a $0.05 discount on the usual price. Required 1. What is the minimum transfer price that the Glass Division would be willing to accept? What is the maximum transfer price that the Florist Division would be willing to pay? Should an internal transfer take place? What would be the benefit (or loss) to the firm as a whole if the internal transfer takes place? 2. Suppose Martha knows that the Glass Division has idle capacity. Do you think that she would agree to the transfer price of $2.45? Suppose she counters with an offer to pay $2.00. If you were Neil, would you be interested in this price? Explain with supporting computations. 3. Suppose that Sonnet, Inc., policy is that all internal transfers take place at full manufacturing cost. What would the transfer price be? Would the transfer take place? 5. Adler Industries is a vertically integrated firm with several divisions that operate as decentralized profit centers. Adler’s Systems Division manufactures scientific instruments and uses the products of two of Adler’s other divisions. The Board Division manufactures printed circuit boards (PCBs). One PCB model is made exclusively for the Systems Division using proprietary designs, while less complex models are sold in outside markets. The products of the Transistor Division are sold in a well-developed competitive market; however, one transistor model is also used by the Systems Division. The costs per unit of the products used bye the Systems Division are presented below: PCB Transistor Direct materials $2.50 $0.80 Direct labor 4.50 1.00 Variable overhead 2.00 0.50 Fixed overhead 0.80 0.75 Total cost $9.80 $3.05 The Board Division sells it s commercial product at full manufacturing cost plus a 25% markup and believes the proprietary board made for the Systems Division would sell for $12.25 per unit on the open market. The market price of the transistor used by the Systems Division is $3.70 per unit. Required 1. What is the minimum transfer price for the Transistor Division? What is the maximum transfer price of the transistor for the Systems Division? 2. Assume the Systems Division is able to purchase a large quantity of transistors from an outside source at $2.90 per unit. Further assume that the Transistor Division has excess capacity. Can the Transistor Division meet this price? 3. The Board and Systems Divisions have negotiated a transfer price of $11 per printed circuit board. Discuss the impact this transfer price will have on each division. 6. Chapin, Inc., owns a number of food service companies. Two divisions are the Coffee Division and the Donut Shop Division. The Coffee Division purchases and roasts coffee beans for sale to supermarkets and specialty shops. The Donut Shop Division operates a chain of donut shops where the donuts are made on the premises. Coffee is an important item for sale along with the donuts and, to date, has been purchased from the Coffee Division. Company policy permits each manager the freedom to decide whether or not to buy or sell internally. Each divisional manager is evaluated on the basis of return on investment and residual income. Recently an outside supplier has offered to sell coffee beans, roasted and ground, to the Donut Shop Division for $4.00 per pound. Since the current price paid to the Coffee Division is $4.50 per pound, Brandi Alzer, the manager of the Donut Shop Division, was interested in the offer. However, before making the decision to switch to the outside supplier, she decided to approach Raymond Jasson, manager of the Coffee Division, to see if he wanted to offer an even better price. If not, then Brandi would buy from the outside supplier. Upon receiving the information from Brandi about the outside offer, Raymond gathered the following information about the coffee: Direct materials $0.90 Direct labor 0.40 Variable overhead 0.70 Fixed overhead* 1.50 Total unit cost $3.50 * Fixed overhead is based on $1,500,000/1,000,000 pounds. Selling price per pound $4.50 Production capacity 1,000,000 pounds Internal sales 100,000 pounds Required Suppose that the Coffee Division is producing at capacity and can sell all that it produces to outside customer. How should Raymond respond to Brandi’s request for a lower transfer price? What will be the effect on firmwide profits? Compute the effect of this response on each division’s profits.
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