Lewis is a large manufacturer of office equipment, including copiers. Electronics Division of Lewis is a cost center. Currently, Electronics Division sells circuit boards to other divisions exclusively. Lewis has a policy that internal transfers are to be priced at full cost (fixed + variable). Thirty percent of the cost of a board is considered fixed.

Electronics Division is currently operating at 75 percent of capacity. Given this excess capacity, Electronics is seeking opportunities to sell boards to non-Lewis firms. The Electronics Division policy on non-Lewis sales states that each job must cover full cost and a minimum 10 percent profit. Electronics Division management will be measured on its ability to make the minimum profit on any non-Lewis contracts accepted.

Copy Products is another Lewis division. Copy Products has recently reached an agreement with Siviy, a non-Lewis firm, for the assembly of sub-systems for a copier.

Copy Products has selected Siviy due to Siviy’s low labor cost. The sub-system, which Siviy will assemble, requires circuit boards. Copy Products has stipulated that Siviy must purchase the circuit boards from Electronics Division because of Electronics’ high quality and dependability. Electronics Division is anxious to accept this new work from Copy Products, as it will increase its workload by 15 percent.

In negotiating a contract price with Siviy, Copy Products needs to take into account the cost of the circuit boards from Electronics Division. The financial analyst assumes that Electronics Division will sell the circuit boards to Siviy at full cost (the same as the internal transfer price). Electronics is considering adding the minimum 10 percent profit margin to its full cost and transferring at that price to Siviy.

Copy Products is preparing to negotiate its contract with Siviy.

Develop and discuss at least three options that may be used to establish the transfer price between Electronics Division and Siviy. Discuss the advantages and disadvantages of each.