Chapter 22, Problem 22.31P

Transfer pricing, external market, goal congruence. Ballantine Corp. produces and sells lead crystal glassware. The firm consists of two divisions, Commercial and Specialty. The Commercial division manufactures 300,000 glasses per year. It incurs variable manufacturing costs of $8 per unit and annual fixed manufacturing costs of $900,000. The Commercial division sells 100,000 units externally at a price of $12 each, mostly to department stores. It transfers the remaining 200,000 units internally to the Specialty division, which modifies the units, adds an etched design, and sells them directly to consumers online.

Ballantine Corp. has adopted a market-based transfer-pricing policy. For each glass it receives from the Commercial division, the Specialty division pays the weighted-average external price the Commercial division charges its customers outside the company. The current transfer price is accordingly set at $12.

Eileen McCarthy, the manager of the Commercial division, receives an offer from Home Décor, a chain of upscale home furnishings stores. Home Décor offers to buy 20,000 glasses at a price of $9 each, knowing that the entire lead crystal industry (including Ballantine Corp.) has excess capacity at this time. The variable manufacturing cost to the Commercial division for the units Home Décor is requesting is $8, and there are no additional costs associated with this offer. Accepting Home Décor’s offer would not affect the current price of $12 charged to existing external customers.

1. A. Calculate the Commercial division’s current annual level of profit (without the new order).
2. B. Compute the change in the Commercial division’s profit if it accepts Home Décor’s offer. Will Eileen McCarthy accept this offer if her aim is to maximize the Commercial division’s profit?
3. C. Would the top management of Ballantine Corp. want the Commercial division to accept the offer? Compute the change in firm-wide profit associated with Home Décor’s offer.