Transfer pricing) Lafayette Co., a profit center of Creole Enterprises, manu¬ factures brake pads to sell internally to other company divisions and exter¬ nally. A set of Lafayette brake pads normally sells for $36. Production and selling costs for a set of brake pads follow:

Hammond Co., another division of Creole Enterprises, wants to purchase 50,000 sets of brake pads from Lafayette Co. during next year. No selling costs are incurred on internal sales.

a. If Lafayette’s manager can sell all the brake pads it produces externally, what should the minimum transfer price be? Explain.

b. Assume that Lafayette Co. is experiencing a slight slowdown in external demand and will be able to sell only 600,000 sets of brake pads exter¬ nally next year at the $36 selling price. What should be the minimum selling price to Hammond Co. under these conditions? Explain.

c. Assume that Ms. El-Deeb, the manager of Hammond Co., offers to pay Lafayette Division’s production costs plus 25 percent for each set of brake pads. She receives an invoice for $1,303,125 but was planning on a cost of $787,500. How were these amounts determined? What created the confusion? Explain. LO.1

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Direct material $4.50 5.70 Direct labor Variable overhead 2.40 Fixed overhead (based on production of 700,000 sets) Variable selling expense 8.25 1.50