PROBLEM 11A–6 Transfer Pricing with an Outside Market [LO5]
Galati Products, Inc., has just purchased a small company that specializes in the manufacture of electronic tuners that are used as a component part of TV sets. Galati Products, Inc., is a decentral- ized company, and it will treat the newly acquired company as an autonomous division with full profit responsibility. The new division, called the Tuner Division, has the following revenue and costs associated with each tuner that it manufactures and sells:
Galati Products also has an Assembly Division that assembles TV sets. This division is cur- rently purchasing 30,000 tuners per year from an overseas supplier at a cost of $20 per tuner, less a 10% purchase discount. The president of Galati Products is anxious to have the Assembly Division begin purchasing its tuners from the newly acquired Tuner Division in order to “keep the profits within the corporate family.”
For (1) and (2) below, assume that the Tuner Division can sell all of its output to outside TV manu- facturers at the normal $20 price.
1. Are the managers of the Tuner and Assembly Divisions likely to voluntarily agree to a transfer price for 30,000 tuners each year? Why or why not?
2. If the Tuner Division meets the price that the Assembly Division is currently paying to its overseas supplier and sells 30,000 tuners to the Assembly Division each year, what will be the effect on the profits of the Tuner Division, the Assembly Division, and the company as a whole?
For (3) through (6), assume that the Tuner Division is currently selling only 60,000 tuners each year to outside TV manufacturers at the stated $20 price.
3. Are the managers of the Tuner and Assembly Divisions likely to voluntarily agree to a transfer price for 30,000 tuners each year? Why or why not?
4. Suppose that the Assembly Division’s overseas supplier drops its price (net of the purchase discount) to only $16 per tuner. Should the Tuner Division meet this price? Explain. If the Tuner Division does not meet this price, what will be the effect on the profits of the company as a whole?
5. Refer to (4) above. If the Tuner Division refuses to meet the $16 price, should the Assembly Division be required to purchase from the Tuner Division at a higher price for the good of the company as a whole? Explain.
6. Refer to (4) on the previous page. Assume that due to inflexible management policies, the Assembly Division is required to purchase 30,000 tuners each year from the Tuner Division at
$20 per tuner. What will be the effect on the profits of the company as a whole?
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