The Super Co. has several divisions, which are full profit centers. This case deals with two divisions: the Standard division and the Refining division. The Standard division produces two products, Super and Regular, about which we have the information shown in Table 1. In the Standard division, fixed costs amount to $3 million per year. Total capacity is estimated to be 100,000 working hours and cannot easily be changed. Currently 20,000 units of each product are sold to outside customers. The sales volume of the Super product is expected to remain unchanged for a long time. The demand for Regular at the prevailing market price is virtually unlimited. Table 1 Standard division’s products (values per unit) Super Regular Sales price $600 $120 Direct material 20 10 Direct wages 280 70 Working time 4 hours 1 hour In the Refining division one of their major products is called Perfect (see Table 2 for information). There are fixed costs of producing Perfect that amount to $400,000 per year. Expected sales are 3000 units. Table 2 Information on Refining division’s Perfect (values/unit) Perfect Sales price $1400 Foreign direct material 600 Domestic direct material 100 Direct wages 500 Working time 5 hours In the Refining division, they have found that the Super product might replace the foreign material in the Perfect product. But in such a case, the working time in the Refining division would increase by 25 percent. As a result, the company wants to investigate the profitability of internal trade in the Super product, including the price limits of each division. Comment on the profitability of the company based on minimum acceptable transfer price for Standard Division. Comment on the profitability of the company based on maximum acceptable transfer price for Refining Division. What is the likely outcome of a free negotiation between the two divisions? On the basis of above analysis, create a rule for optimal transfer pricing referring to ‘direct costs’ and ‘opportunity costs’
The Super Co. has several divisions, which are full profit centers. This case deals with two divisions: the Standard division and the Refining division. The Standard division produces two products, Super and Regular, about which we have the information shown in Table 1. In the Standard division, fixed costs amount to $3 million per year. Total capacity is estimated to be 100,000 working hours and cannot easily be changed. Currently 20,000 units of each product are sold to outside customers. The sales volume of the Super product is expected to remain unchanged for a long time. The demand for Regular at the prevailing market price is virtually unlimited.
Table 1
Standard division’s products (values per unit)
Super Regular
Sales price $600 $120
Direct material 20 10
Direct wages 280 70
Working time 4 hours 1 hour
In the Refining division one of their major products is called Perfect (see Table 2 for information). There are fixed costs of producing Perfect that amount to $400,000 per year. Expected sales are 3000 units.
Table 2
Information on Refining division’s Perfect (values/unit)
Perfect
Sales price $1400
Foreign direct material 600
Domestic direct material 100
Direct wages 500
Working time 5 hours
In the Refining division, they have found that the Super product might replace the foreign material in the Perfect product. But in such a case, the working time in the Refining division would increase by 25 percent. As a result, the company wants to investigate the profitability of internal trade in the Super product, including the price limits of each division.
- Comment on the profitability of the company based on minimum acceptable transfer price for Standard Division.
- Comment on the profitability of the company based on maximum acceptable transfer price for Refining Division.
- What is the likely outcome of a free negotiation between the two divisions?
- On the basis of above analysis, create a rule for optimal transfer pricing referring to ‘direct costs’ and ‘opportunity costs’.
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