U.S. Pump is a multidivisional firm that manufactures and installs chemical piping and pump systems. The valve division makes a single standardized valve. The valve division and the installation division are currently involved in a transfer pricing dispute. Last year, half of the valve division's output was sold to the installation division for $40 and the remaining half was sold to outsiders for $60.
The existing transfer price has been set at $40 per pump through a process of negotiation between the two divisions, with the involvement of senior management. The installation division has received a bid from an outside valve manufacturer to supply it with an equivalent valve for $35 each.
The manager of the valve division has argued that if it is forced to meet the external price of $35, it will lose money on selling internally.
The operating data for last year for the valve division are as follows:
VALVE DIVISION
Operating Statement
Last Year
To Installation Division To Outside
- Sales 20,000 @$40 $800,000 20,000 @ $60 $1,200,000
- Variable cost 20,000 @ $30 (600,000) (600,000)
- Allocated fixed cost (135,000) (135,000)
- Gross margin $ 65,000 $ 465,000
Analyze the situation and recommend a course of action. What should U.S. Pump's senior managers do?