Plevna Manufacturing makes and distributes small prefabricated homes in kits. The kits contain all pieces needed to assemble the home. All that is required is that the builder erect the home on a foundation. Plevna Manufacturing is organized into two divisions: the manufacturing division and the sales division. Each division is evaluated on the basis of its reported profits. The transfer price between the manufacturing division, where the kits are made, and the selling division, which sells the kits, is variable cost plus 10%, a total of about $33,000. The selling price per kit is about $40,000, and selling and distribution costs are about $5,000 per home kit. The total costs that do not vary in proportion with volume at Plevna Manufacturing amount to about $2,000,000 per year: about $1,500,000 in manufacturing and about $500,000 in the selling division. The company is currently operating at capacity, which is dictated by the machinery in the manufacturing division. Each kit requires about 10 hours of machine time, and the total available machine time is 5,000 hours per year. Plevna Manufacturing is making and selling about 500 kits per year. Increasing the plant capacity is not a viable option in the foreseeable future. Willie Scott is the firm’s salesperson. Willie has been approached a number of times recently by people wanting to buy cottages to erect on recreational properties. The cottages would be made by modifying the existing home product. The modification process would begin with a completed home kit. The manufacturing division would then incur additional materials and labor costs of $3,000 and three hours of machine time to convert a home kit into a cottage kit. Willie is proposing that the company split the sales division into two divisions: home sales and cottage sales. The new divisional structure would have no effect on existing administrative, personnel, or selling costs.

Required

Suppose the new division is created. Discuss the issues in choosing a transfer price in this situation. What transfer price for each of the two products, home and cottage kits, would you recommend and why? (If you feel that the appropriate transfer price for each product can be within a range, specify the range.)