New product opportunities and transfer pricing Plevna Manufacturing LO 6 makes and distributes small prefabricated homes in kits. The kits contain all the 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 manufactur¬ ing division and the sales division. Each division is evaluated based on its re¬ ported 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 Man¬ ufacturing amount to about $2,000,000 per year—$1,500,000 in manufac¬ turing and $500,000 in the selling division. Currently the company is operating at capacity, which is dictated by the machinery in the manufactur¬ ing division. Each kit requires about 10 hours of machine time and the total available machine time is 5000 per year. Plevna Manufacturing is making and selling about 500 kits per year. Increasing the plant capacity in the foresee¬ able future is not a viable option.

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 prod¬ uct. The modification process would begin with a completed home kit. The manufacturing division would then incur additional materials and labor costs of $3000 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 divi¬ sions— home sales and cottage sales. The new divisional structure would have no effect on existing administrative, personnel, or selling costs.

REQUIRED Suppose that the new division is created. Discuss the issues in choosing a transfer price in this situation. What transfer price for each of the two prod¬ ucts, 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.)

(LO 1)