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Sir,
Here are the extracts from the question :
“Rotech group comprises two companies, W Co and C Co.
W Co is a trading company with two divisions : Design division (designs wind turbines and supplies designs to customers) and Gearbox division (manufactures gearboxes for car industry)
C Co manufactures components for gearboxes, sells components globally and also supplies W Co with components for its Gearbox manufacturing division.External sales of C Co = $8,010,000
Sales to Gearbox Division from C Co = $7,550,000part b) C Co is currently working full capacity. The Rotech’s Group’s policy is that group companies and divisions must always make internal sales before selling outside the group. Similarly, purchases must be made from within the group wherever possible. However, the group divisions and companies are allowed to negotiate their own transfer prices without interference from Head Office.
C Co has always charged the same price to the Gearbox division as it does to its external customers. However, after being offered 5% lower price for similar components from an external supplier, the manager of the Gearbox division feels strongly that the transfer price is too high and should be reduced. C Co currently satisfies 60% of the external demand for its components. Its variable costs represents 40% of revenue.
Required: Advise, using suitable calculations, the total transfer price or prices at which the components should be supplied to the Gearbox division from C Co.”
So far, I have done the following :
Satisfied sales = $8,010,000
Unsatisfied sales = $5,340,000Referring to the model answer, I do not understand this phrase “The current internal sales of $7,550,000; $5,340,000 could be sold externally if they were not sold to Gearbox division. In order for C Co not to be any worse off from selling internally, these sales should be made at the current price of $5,340,000, less any reduction in costs which C Co saves from not having to sell outside the group (perhaps lower administrative and distribution costs)”
Could you please break it down for me so I could understand what I am suppose to do for the transfer price to Gearbox division? 🙁
There is no need to type out a whole question like this.
It is a past exam question, so I can find it myself.You will know from our free lectures on transfer pricing that the minimum transfer price must be the marginal cost plus any lost contribution.
Here, C is transferring to the gearbox division everything they want.
However, C is only satisfying 60% of the external demand. So they could sell the remaining 40% externally. So to transfer those items to the Gearbox division they should charge a minimum of the price they could sell them for externally.
For the rest of their production (that they could not sell outside) the minimum price they should charge is the marginal cost of producing them.To be honest, I don’t get the whole part B for this question. Even after trying to refer it to the exercises and examples that I did on the lecture notes on “Transfer Pricing” countless of times.
Let me try again as this is how I understand the question.
$5,340,000 is the contribution to C Co and then, it is added to the marginal cost (variable cost of $884k ($2,210,000 x 40%) from the remaining internal sales of $2,210,000 ($7.55mil – $5.34mil) making it $6.224mil for the minimum transfer price to Gearbox division??
Sir, past year (December 2013) question 2 : TPAR part b).
I do not know why in the given answer by the examiner its stated as 1,000 units for small panels and 1,500 units for large panels.
I did mine according to the ranks of the return per factory hour which is Large panels is 1 and small panel is 2.
So the units I put large panel as 1,800 units (maximum) multiplied it with its machine hours per unit and the remainder from the 2,700 bottleneck hours will be the hours for small panels resulting to 300 units.
Am I wrong using the method which you’ve used for your lecture notes?
In future you must start a new thread when it is a new topic (this is obviously not a question on transfer pricing).
The question says that they have agreed already to supply a minimum of 1,000 small papers – so they have to 🙂
Hi,
I don’t understand the calculation of the unsatisfied external demand.Assist explaing.
You know what the external demand is.
Also you know how many they can produce and how many they supply to the other division, and therefore how many they are able to supply externally.
The difference between the external demand, and the number they are able to supply is the unsatisfied external demand.
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