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Transfer Pricing Basics

) Transfer Pricing Basics

Nelcro Company's Electrical Division produces a high-quality transformer. Sales and cost data on the transformer follow:
Selling price per unit on the outside market...............$40
Variable costs per unit...........................................$21
Fixed costs per unit (based on capacity).....................$9
Capacity in units................................................60,000

Nelcro Company has a Motor Division that would like to begin purchasing this transformer from the Electrical Division. The Motor Division that would like to begin purchasing this transformer from the Electrical Division. The Motor Division is currently purchasing 10,000 transformers each year from another company at a cost of $38 per transformer. Nelcro Company evaluates its division managers on the basis of divisional profits.

Required:
1. Assume that the Electrical Division is now selling only 50,000 transformers each year to outside customers.
a. From the standpoint of the Electrical Division, what is the lowest acceptable transfer price for transformers sold to the Motor Division?
b. From the standpoint of the Motor Division, what is the highest acceptable transfer price for transformers acquired from the Electrical Division?
c. If left free to negotiate without interference, would you expect the division managers to voluntarily agree to the transfer of 10,000 transformers from the Electrical Division to the Motor Division? Why or why not?

2. Assume that the Electrical Division is now selling all of the transformers it can produce to outside customers.
a. From the standpoint of the Electrical Division, what is the lowers acceptable transfer price for transformer sold to the Motor Division?
b. From the standpoint of the Motor Division, what is the highest acceptable transfer price for transformers acquired from the Electrical Division?
c. If left free to negotiate without interference, would you expect the division managers to voluntarily agree to the transfer of 10,000 transformers from the Electrical Division to the Motor Division? Why or why not?
d. From the standpoint of the entire company, should a transfer take place? Why or why not?

Solution Summary

Transfer pricing basics are examined.

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