Assignment
Recently Grey Owl Vineyard decided to produce its first non-alcoholic red wine. Grey Owl's chief winemaker believed that the Pinot Noir grape variety would produce the best non-alcoholic red wine possible. Therefore the manager of the Purchasing Department was asked to purchase a quantity of Pinot Noir grapes to be used in the production of non-alcoholic red wine. The Purchasing manager knew that Grey Owl Vineyard's own Pinot Noir grapes were among the best on the market. Therefore he asked the Vineyard Sales manager to provide him with a transfer price quote for the Pinot Noir grapes.
The transfer price provided by the Vineyard Sales manager is contained below. Transfer Price Per 10 Kilograms of Pinot Grapes
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Transfer price (based on a 50% mark up on Full Cost)
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$43.50
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Full Cost
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Pinot Noir Grapes (at $1.20 per kilogram)
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$12.00
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Machine Picking (80% variable)
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3.00
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Cleaning (100% variable)
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2.50
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Additional Preparation costs (100% fixed)
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4.00
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Packaging (100% variable)
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2.00
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Delivery (100% variable)
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0.50
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Selling and Administration (30% fixed)
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5.00
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Total Full Cost
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$29.00
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When the Purchasing manager saw the transfer price he was extremely disappointed because the Vineyard Sales manager had used full cost as the basis for determining the grape transfer price, when she usually used variable cost. Furthermore, the mark-up was usually only 25%, not the 50% listed.
The Purchasing Manager asked the Vineyard Sales manager to explain why the transfer price was so high and was told that the transfer price was equal to the selling price Vineyard Sales charged to its external customers.
The Purchasing manager was not happy as he knew that there was a surplus of Pinot Noir grapes this season and therefore the Vineyard Sales Department could not sell all its produce. As a result the Vineyard Sales Department has enough Pinot Noir grapes to supply both external customers and the Purchasing Department.
Furthermore he knew that some of the costs in the quote would not be incurred on an internal transfer. In particular, the grapes would not need cleaning or delivery and packaging would be very basic which would save 80% of packaging costs.
REQUIRED:
(a) Outline two reasons why a transfer pricing problem has arisen at Grey Owl Winery.
(b) The Purchasing Department manager has found a supplier for the Pinot Noir grapes who is willing to charge $35 per 10 kilograms of grapes. He isn't sure that the quality will be adequate, but given the significant difference in price, compared to the Vineyard Sales Department quote, he is willing to take the risk.
In the best interests of Grey Owl Vineyard, determine the optimal sourcing decision for the Pinot Noir grapes. You must explain your answer fully and provide properly labelled calculations to support your answer.
(c) The Purchasing Manager has informed the Vineyard Sales Manager that he will only purchase the department's Pinot Noir grapes if the transfer price is equal to the external supplier's market price of $35 per 10 kilograms of grapes. Should the Vineyard Sales Manager accept this offer? Explain and justify your answer.
(d) Assume the Vineyard Sales Department could sell all its Pinot Noir grapes to external customers. Would this change the optimal sourcing decision you determined in part b)? You must explain your answer fully and provide properly labelled calculations to support your answer.