Transfer Pricing
TEB, Inc., which manufactures video games, consists of two divisions, each operating as a profit center. Division A makes a component that is needed by Division B; however, if the price from Division A is too high, Division B has indicated it would purchase the component from an outside supplier. Additional information related to the divisions is:
- Division B's annual needs for component 10,000 units
- Division As variable cost per unit $150
- Division A's annual fixed cost $1,500,000
- Price per unit from outside supplier $160
Answer the following independent questions. To explain independent, when answering requirement 2, utilize the given information above and the information in requirement 2 and ignore any information in requirement 1. When answering requirement 3, utilize the given information above and the information in requirement 3 and ignore the information in requirements 1 and 2.
Required (be sure to number the parts 1, 2, and 3 in your solution, to get grade credit):
1. Assume Division A has excess capacity and cannot use the capacity to sell components to outsiders. Also assume the decision has been made by management that Division B must purchase from Division A. What is the most logical minimum and maximum acceptable transfer price? Briefly explain why your minimum is your minimum and your maximum is your maximum.
2. Assume Division A has excess capacity and cannot use the capacity to sell components to outsiders. Also assume Division A can cut its fixed costs by $200,000 if it does not sell to Division B. For the benefit of the company as a whole, should Division B buy the parts internally or externally? Provide detailed, labeled computations that show how much money will be saved by utilizing your suggested solution.
3. Assume Division A can sell components to outsiders for $155 each running at 100% of capacity. For the benefit of the company as a whole, should Division B buy the parts internally or externally? Provide detailed, labeled computations that show how much money will be saved by utilizing your suggested solution.