Question: Transfer Prices and Idle Capacity The Eugene division of Union Furniture purchases lumber, which it uses to fabricate tables, chairs, and other wood furniture. It purchases most of the lumber from Shasta Mill, also a division of Union Furniture. Both the Eugene division and Shasta Mill are profit centers. The Eugene division proposes to produce a new Shaker-style chair that will sell for $95. The manager is exploring the possibility of purchasing the required lumber from Shasta Mill. Production of 800 chairs is planned, using capacity in the Eugene division that is currently idle. The Eugene division can purchase the lumber needed for one chair from an outside supplier for $72. Union Furniture has a policy that internal transfers are priced at fully allocated cost. Assume the following costs for the production of one chair and the lumber required for the chair:
1. Assume that the Shasta Mill has idle capacity and, therefore, would incur no additional fixed costs to produce the required lumber. Would the Eugene division manager buy the lumber for the chair from the Shasta Mill given the existing transfer-pricing policy? Why or why not? Would the company as a whole benefit if the manager decides to buy from the Shasta Mill? Explain.
2. Assume that there is no idle capacity at the Shasta Mill and the lumber required for one chair can be sold to outside customers for $72. Would the company as a whole benefit if the Eugene manager buys from Shasta? Explain.