Recently, Sasha Lebron, the chief executive officer of Global Tronics, decided to investigate the transfer pricing policy. He was concerned that the current method of pricing internal transfers might force decisions by divisional managers that would be suboptimal for the firm. As part of his inquiry, he gathered some information concerning Part Z35, used by Machines Division in its production of a basic scanner, Model SC20.
The Machines Division sells 40,000 units of Model SC20 each year at a unit price of $42. Given current market conditions, this is the maximum price that the division can charge for Model SC20. The cost of manufacturing the scanner follows:
Part Z35
$6.50
Direct materials
12.50
Direct labor
3.00
Variable overhead
1.00
Fixed overhead
15.00
Total unit cost
$38.00
The scanner is produced efficiently, and no further reduction in manufacturing costs is possible.
The manager of the Parts Division indicated that she could sell 40,000 units (the division’s capacity for this part) of Part Z35 to outside buyers at $12 per unit. The Machines Division could also buy the part for $ 12 from external suppliers. The Parts Division manager supplied the following details on the manufacturing cost of the component:
Direct material
$2.50
Direct labor
0.50
Variable overhead
1.00
Fixed overhead
2.50
Total unit cost
$6.50
REQUIRED
1. Compute the contribution margin for Parts Division, Machines Division, and Global Tronics, Inc. associated with the sale of Part Z35 and Model SC20. Show ALL workings.
2. Suppose that Sasha Lebron abolishes the current transfer pricing policy and gives division autonomy in setting transfer prices.
(i) Can you predict what transfer price the manager of the Parts Division will set?
(ii)What should the minimum transfer price for this part be?
(iii) What should the maximum transfer price be?
3. Given the new transfer pricing policy, predict how this will affect the production decision for Model SC20. How many units of Part Z35 will the manager of the Machines Division purchase, either internally or externally?
4. Given the new transfer price set by the Parts Division and your answer to Requirement 3, how many units of Part Z35 will be sold externally?
5. Given your answers to Requirements 3 and 4, compute the firm wide contribution margin. What has happened? Was Sasha ’s decision to grant additional decentralization good or bad? Why?
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