Transfer Pricing Problem. The Tooele Company has a production division which is currently mnufacturing 120,000 units but

Transfer Pricing Problem. The Tooele Company has a production division which is currently mànufacturing 120,000 units but has a capacity of 180,000 units. The variable cost of the product is \(\$ 22\) per unit, and the total fixed cost is \(\$ 720,000\) or \(\$ 6\) per unit based on current production.

The Sales Division of the Tooele Company offers to buy 40,000 units from the Production Division at \(\$ 21\) per unit. The Production Division manager refuses the order because the price is below variable cost. The Sales Division manager argues that the order should be accepted since by taking the order the Production Division manager can lower the fixed cost per unit from \(\$ 6\) to \(\$ 4.50\). (Output will increase to 160,000 units.) This decrease of \(\$ 1.50\) in fixed cost per unit will more than offset the \(\$ 1\) difference between the variable cost and the transfer price.

\section*{Required:}

1. If you were the Production Division manager, would you accept the Sales Division manager's argument? Why or why not? (Assume that the 120,000 units currently being produced sell for \(\$ 30\) per unit in the external market.)

2. From the viewpoint of Tooele Company, should the order be accepted if the manager of the Sales Division intends to sell each unit to the outside market for \(\$ 27\) after incurring an additional processing cost of \(\$ 2.25\) per unit? Explain.