Transfer Pricing

The paper Division of Edu-Tech, Inc., produces photographic paper that can be sold externally or internally to Edu-Tech’s School Photography Division. Sales and cost data per package of photographic paper follows:

Unit selling price $3.95
Unit variable product cost $2.25
Unit product fixed cost* $1.20
Practical capacity 500,000 units (packages)

*$600,000/500,000

During the coming year, the Paper Division expects to sell 350,000 packages of photographic paper. The School Photography Division currently plans to buy 150,000 packages of this paper on the outside market for $3.95 each. Penelope Cruise, manager of the Paper Division, has approached Tom Cruz, manager of the School Photography Division, and offered to sell the 150,000 packages of paper for $3.75 each. Penelope explained to Tom that she can avoid selling costs of $0.40 per package and she would split the savings by offering a $0.20 discount on the usual price.

REQUIRED

1. (i)What is the minimum transfer price the Paper Division would be willing to accept?
(ii)What is the maximum transfer price that the School of Photography Division would be willing to pay?
(iii) Should an internal transfer take place?
(iv)What would be the benefit (or loss) to the firm as a whole if the internal transfer takes place? (6 marks)

2. Suppose Tom knows that the Paper Division has idle capacity. Do you think that he would agree to the transfer price of $3.75? Suppose he counters with an offer to pay $3.20. If you were Penelope, would you be interested in this price? Explain with supporting computations. (4 marks)

3. Suppose that Edu-Tech, Inc.’s policy is that all internal transfers take place at full manufacturing cost.
(i) What would the transfer price be?
(ii)Would the transfer take place? (5 marks)