Evaluate Transfer Price System: MBR, Inc.. consists of three divisions: Boston Corporation, Raleigh Company, and Memphis Company. The three divisions operate as if they were independent companies. Each division has its own sales force and production facilities. Each division management is responsible for sales, cost of operations, acquisition and financing of divisional assets, and working capital management. MBR corporate management evaluates the performance of the divisions and division managements on the basis of ROI. Memphis Division has just been awarded a contract for a product that uses a component manufactured by the Raleigh Division, which is operating well below capacity, as well as by outside suppliers. Memphis used a cost figure of $3.80 for the component manufactured by Raleigh in preparing its bid for the new product. This cost figure was supplied by Raleigh in response to Memphis's request for the average variable cost of the component and represents the standard variable manufacturing cost and variable marketing costs. Raleigh's regular selling price for the component Memphis needs for the new product is $6.50. Raleigh management indicated that it could supply Memphis with the required quantities of the component at the regular selling price less variable selling and distribution expenses. Memphis management responded by offering to pay standard variable manufacturing cost plus 20 percent. The two divisions have been unable to agree on a transfer price. Corporate management has never established a transfer price policy. The corporate vice president of finance suggested a price equal to the standard full manufacturing cost (that is, no selling and distribution expenses) plus a 15 percent markup. This price has been rejected by the two division managers because each considered it grossly unfair. The unit cost structure for the Raleigh component and the suggested prices are shown below.

Required:

a. Discuss the effect each of the proposed prices might have on the Raleigh Company management's attitude toward intracompany business.

b. Is the negotiation of a price between the Memphis and Raleigh divisions a satisfactory method to solve the transfer price problem? Explain your answer.

c. Should the corporate management of MBR, Inc., become involved in this trans- fer price controversy? Explain your answer.

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Costs: Standard variable manufacturing cost $3.20 Standard fixed manufacturing cost 1.20 Variable selling and distribution expenses .60 $5.00 Prices: Regular selling price $6.50 Regular selling price less variable selling and distri- bution expenses ($6.50 - .60) $5.90 Variable manufacturing plus 20% ($3.20 x 1.20) $3.84 Standard full manufacturing cost plus 15% ($4.40 x 1.15) $5.06