AMP Transfer Pricing Case

AMP Industries is a multi-national firm built around batteries and the use of batteries in the automotive industry. AMP Industries is made up of two divisions, a Battery division that manufactures batteries and an Auto division that uses batteries from the Battery division to make a line of fully electric cars. Currently both divisions only transact internally the Battery division sells only to the Auto division and the Auto division purchases all of their required batteries from the Battery division. The firm allows each division manager to make decisions that are best for their division with a minimum of interference from top-level corporate management.

The Battery division is located in Canada while the Auto division is located in the United States. Because the Battery division is located in Canada, the Auto division will need to pay a 10% tariff on top of whatever transfer price is paid to the Battery division (the Auto division will need to make the tariff payment to the US government). The Battery Division is subject to a 15% corporate income tax on their operating profits since they are based in Canada while the Auto division is subject to a 21% corporate income tax on their operating profits since they are based in the US.

The transfer price between divisions had been $8,900 per unit until June of 2019 when Olivia, manager of the Battery division informed the manager of the Auto division that the price would go up to $11,280 per unit starting in July 2019. Olivia has made this proposed change in the transfer price because she has recently made significant investments in new equipment in her division and after making these investments and carefully tracking her divisions total cost over the last 6 months, she believes a significant increase in the transfer price is warranted. In her calculation of the new proposed transfer price Olivia has built in what she believes is a reasonable 20% profit margin for her division. Olivias calculation of the new proposed transfer price is based on the following information for her division over the last 6 months in which her division produced and sold 11,500 units to the Auto division:

Battery Division Costs (based on prod of 11,500 batteries)
Direct Materials	$35,407,235
Direct Labor	$27,945,345
Variable Overhead	$14,592,925
Fixed Overhead	$22,212,710
Variable SG&A costs	$2,511,715
Fixed SG&A costs	$1,106,070
Total costs	$103,776,000

The fixed overhead cost for the Battery division represents the costs of the facility and equipment. If the Battery division is shut down, AMP Industries estimates that 30% of this fixed overhead would be eliminated but the remaining 70% could not be eliminated.

The variable SG&A costs for the Battery Division represent the costs of shipping the batteries to the Auto division in the US. The fixed SG& A costs for the Battery division represent cancelable lease expenses.

Ellis, the manager of the Auto division is concerned with the proposed new transfer price. Ellis has put together the following information for the costs for his division other than battery costs for the last 6 months (these costs do not include any costs for the batteries including any relevant tariffs).

Auto Division Costs (based on prod of 11,500 cars)
Direct Materials	$65,521,365
Direct Labor	$116,418,180
Variable Overhead	$38,406,665
Fixed Overhead	$25,281,255
Variable SG&A costs	$17,673,545
Fixed SG&A costs	$41,448,990
Total costs	$304,750,000

Because the average price per car sold by the Auto division is $38,500, Ellis is concerned that the new transfer price for the battery will cause his division to have negative operating income.

The Auto division believes they can produce and sell 12,300 cars over the next 6 months so they are projecting a need for 12,300 batteries over that time period. The Auto division expects to be able to sell these 12,300 cars at their typical sales price of $38,500 per car.

Because of the proposed increase in the transfer price for the internally produced battery, Ellis has asked for a bid from a possible alternative battery supplier that is known to produce high quality batteries. He received a quote for a comparable battery from the external supplier for $9,200 per unit. The external supplier is located in Mexico and therefore any batteries purchased from this external supplier will be subject to a 15% tariff (as always, the tariff will need to be paid by the Auto division to the US government).

Part A: What are the minimum and maximum transfer prices for the 12,300 batteries needed in the next 6 months that would be acceptable to the Battery and the Auto Divisions? Why are these the minimum and maximum prices? (show your calculations). Hint: consider relevant fixed costs.

Part B: What is the projected total operating income for AMP Industries for the next six months if the internal transfer of the 12,300 batteries takes place at $11,280 per unit? What is AMP Industries projected total operating income if the internal transfer does not take place? Assume there is no external market for the batteries produced by the Battery Division. Hint: consider irrelevant fixed costs.

Part C: Assuming an internal transfer takes place, what transfer price would result in AMP Industries making the most overall net income? Assume the transfer price can only range between the minimum and maximum transfer prices from part A and that the only difference between operating and net income for AMP Industries is income taxes.

Part D: Assume that Olivia has found another buyer for the batteries her division produces who is willing to pay $10,900 per battery. This potential new buyer is also located in Canada so the variable shipping costs for the Battery division would be reduced to $90 per unit. Would AMP Industries want the Battery division to sell externally or internally? Assume a price of $11,280 per unit if sold internally also assume the same number of batteries would be sold internally or externally (12,300) and that the Battery division does not have excess capacity.

Part E: Based on your work on the case in Parts A through D above and your overall understanding of transfer prices and divisional manager incentives, provide at least two reasons why AMP Industries may want to consider giving their divisional managers less decision-making authority and two reasons why they may want to continue to give their division managers full decision-making authority for their division with minimal influence from top corporate management.