Case Scenario: "U.S. Pump Systems"
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 Divisions
|
To Outside
|
|
SALES
|
20,000@40
|
$800,000
|
20,000@60
|
$1,200,000
|
|
VARIABLE COSTS
|
20,000@30
|
(600,000)
|
|
(600,000)
|
|
ALLOCATED FIXED COSTS
|
|
(135,000)
|
|
(135,000)
|
|
GROSS MARGIN
|
|
$65,000
|
|
$465,000
|
Analyze the situation and recommend a course of action. What should installation division managers do? What should valve division managers do? What should U.S. Pump's senior managers do?