Assume Two Divisions, P (Producing) and B (Buying) of a Company

question 59

Essay

Assume two divisions, P (producing) and B (buying) of a company are both treated as investment centers for performance evaluation purposes. Division B requires 1,000 units of product that it can either purchase externally on the open market for $13.50 per unit, or obtain internally from Division P. The incremental (i.e., out-of-pocket) costs to Division P are estimated at $12.00 per unit. Because of spot shortages of this product in the open market, it is sometimes possible for Division P to sell at a price higher than the normal market price. Such is currently the case: Division P has an offer to sell 1,000 units at a gross selling price of $15.50 per unit. In addition to the normal incremental production costs, Division P would have to pay a $0.50 sales commission cost for each unit sold externally.
Required:
1. If Division B purchased the units externally, would the firm as a whole benefit or lose (in terms of a short-term financial impact)? Show calculations.
2. Apply the general transfer pricing model to this situation. What is the minimum transfer price indicated for each of the 1,000 units in question? Show calculations.
3. What is the likely consequence, from a decision standpoint, if the transfer price is set at the amount stipulated by the general transfer pricing rule?

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Definitions:

Market Risk

The risk of losses in investments due to factors that affect the entire market, such as economic changes or political events.

Economic Events

Various incidents or transactions that may affect a country's economy, including government policies, market movements, and natural disasters, which can influence financial markets and economic health.

Probability Distribution

A function in mathematics that supplies the likelihoods of various potential outcomes of an experiment.

Standard Deviation

A measure of the amount of variation or dispersion of a set of values, used in statistics and finance to measure risk or volatility.