5. Transfer Pricing

BC Lumber has a raw lumber division and a finished lumber division. The variable costs are:

o Raw lumber division: $100 per 100 board feet of raw lumber.

o Finished lumber division: $125 per 100 board feet of finished lumber.

Assume that no board feet are lost in processing raw lumber into finished lumber. Raw lumber can be sold at $200 per 100 board feet. Finished lumber can be sold at $275 per 100 board feet.

Required:

Part 1: Should BC Lumber process raw lumber into its finished form? Show your calculations. (5 marks)

Part 2: Assume that internal transfers are made at 110% of variable cost. Will each division maximize its division operating-income contribution by adopting the action that is in the best interests of BC lumber as a whole? Explain. (8 marks)

Part 3: Assume that internal transfers are made at market prices. Will each division maximize its division operating-income contribution by adopting the action that is in the best interests of BC Lumber as a whole? Explain. (4 marks)