Transfer Pricing

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Transfer Pricing Question

1) BADM4280 Paper Ltd. is a division of GH Inc. BADM4280 Paper Ltd. produces paper and sells it to a number of companies, as well as to GH Inc. who uses it in their textbook division. Recently, the vice president of marketing for GH Inc. approached BADM4280 Paper Ltd. with a request to make 20,000 units of a special paper product. The following information is available regarding the BADM4280 Paper division:

Selling price of regular paper per unit$80
Variable cost of regular paper per unit45
Additional variable cost of special paper per unit25

The textbook division can purchase the special paper from an outside source for $75 per unit, plus shipping. The shipping equals $2 per unit.

Required:
A) Calculate the transfer price for each of the following situations:

1.BADM4280 Paper Ltd. has available capacity.

2.BADM4280 Paper Ltd. has no available capacity and would have to forgo sales of 20,000 units to existing customers to meet this request.

3.BADM4280 Paper Ltd. has no available capacity and would have to forgo sales of 30,000 units to existing customers to meet this request.

B) What other factors should be considered?

C) If GH Inc. insists that the transfer be made at a price it determines in all cases, how should BADM4280 Paper Ltd. be evaluated?

2) GH Inc. has two divisions. The paper division produces cardboard, which it can sell externally or internally to the box division. Both the paper and the box divisions are evaluated as profit centres. The firm has a policy of transferring all internal products at market price. The market price for the cardboard is $70 per unit, and the market price for the box is $100 per unit. Variable costs for the cardboard are $30 per unit. Per unit cost of manufacturing the boxes is $40 plus the cost of the cardboard. One unit of cardboard is needed to produce one unit of boxes.

Required:
A) Will the box division purchase the cardboard from the paper division if the current company policy is followed? Show your calculations.

B) If the paper division is currently selling 5,000 units per week, and it has capacity to manufacture 10,000 units, should the paper division sell the cardboard to the box division from GH Inc.’s perspective? How many units should it sell? Show your calculations.

C) At what price should the transfer be made?

Solution
1A)
1.Assuming that BADM4280 Manufacturing has available capacity, variable cost would be ($45 + $25) or $70 and the opportunity cost would be zero. Therefore, the minimum transfer price would be $70 = $70 + $0.

The textbook division can buy the special paper from an outside source for $75 + $2 or $77 per unit, and therefore would not pay more than $77.

Therefore the transfer would take place between $70 and $77 per unit.

2.Assuming no available capacity, and that the new units produced would be equal to the number of standard units forgone, variable cost of the special paper would be ($45 + $25) or $70 and the opportunity cost would be ($80 - $45) or $35. Therefore, the minimum transfer price would be $105 = $70 + $35.

The textbook division can buy the special paper from an outside source for $75 + $2 or $77 per unit, and therefore would not pay more that $77 per unit.

Therefore the transfer would not occur.

3.Assuming no available capacity, and that in order to produce the 20,000 units of special paper, 30,000 units of the standard paper would be forgone, the minimum variable cost would be ($45 + $25) or $70 and the opportunity cost would be:

=
Total contribution margin on standard paper ($80-$45) X 30,000 units
Number of units of special paper 20,000 units

Therefore, the minimum transfer price would be $122.50 = ($45 + $25) + $52.50 per unit.

The textbook division can buy the special paper from an outside source for $75 +...
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