Assume that shareholders need an average return of 15%. LTD Interest Rates - arranged by the corporate at 8% Tax rate for EEC is 30% Risk Adjustment factor for cost of capital is assumed at 1.25 for all divisions. Round of the cost of capital to the nearest whole number. ROI for EEC is based on Net Asset of Divisions. Exhibit B Quote from RD to ID: Unit Transfer Pricing Supply of 500 units of modified Alpha I Transferred-in Cost from CD to RD (Exhibit D) $500 Modification premium from CD to RD 65 Recovery of R & D Investment (Royalty) - see notes below 100 Total Product Cost $665 Mark-up @ 20% (rounded) 135 $800 Transfer Price to ID As a financial policy, the investment in R & D facility costs of $6,000,000 would be amortized over a production of 60,000 units. Royalty per unit is thus $100. RD has been successful in selling Alpha. It has sold 50,000 units in the open market. It hopes to recover the royalty balance in the next couple of year, as demand exists in the open market for the unmodified Alpha. Exhibit C: Bid Price for the Italian Proposal (500 units using modified Alpha as a part of ID Product) Total Unit (500 units) Direct Material Direct Labour Variable Overhead Fixed Overhead $ 250,000 * 500 420,000 * 840 20,000 40 100,000 200 I $ 790,000 * 1,580 Mark-up @ 20% 160,000 320 Proposed Bid S 950,000 or $1,900/Unit *Includes the transfer price of $800 for the modified Alpha (Exhibit B). Exhibit D Direct Material Direct Labour Unit Cost Structure of Alpha (Generic prototype) $ 180 160 30 45 $415 85 $ 500 Manufacturing Variable Overhead Fixed Overhead Total Product Cost Mark-up @ 20% (rounded) Unit Cost Alpha (base) Note: The above cost does not include royalty charged to customers @ $100/unit Other Notes: 1. Sam had repeatedly stated at various meetings that his focus is on growth. 2. Jennifer feels that MCL should use key financial metrics and that MCL needs to be profitable and sustainable before thinking of growth. EXPANSION IN EUROPE AND DIVISIONAL CONFLICT Ted Schneider, the Divisional VP of ID had recently indicated to Ian that ID would be bidding on a lucrative contract to supply 500 of its devices to Italy that uses modified Alpha. Winning this contract may lead to continued long-term business prospects in France, Italy, and Spain. He complained that RD needed to lower the transfer price of $800 for the modified Alpha to win this contract and RD should act in the best interest of EEC. It would be too onerous for him to compete and will miss this opportunity. (Exhibit B) Market research revealed that quotations from two other suppliers ranged between $550 (France) and $600 (Germany) comparable to Alpha specifications. The German supplier would consider offering a discount of $100 per unit if RD can share their technology and blueprints with them. The German firm can replicate Alpha to exact specifications. Michelle Dubois, the divisional VP of RD complained to Ian that Ted Schneider - divisional VP of ID would buy the least-cost French supplier and not act in the best interest of EEC. Ian arranged a meeting with the divisional managers to address 2021 results and discuss transfer pricing issues and focus on divisional cooperation and their performance. MEETING Ian Scott (CEO): Good morning everybody! Ted, you seem to have some serious concerns with Michelle about transfer price from her division. I have also asked Naomi Slade, our new CFO to join us to understand some of these numbers and her independent thoughts. Michelle Dubois (VP-RD): Ian, I thought our policy was to internally source as much as possible. We have developed this Alpha and have invested a lot in R & D expenditures. The price of $800 covers our cost plus royalty, modifications costs from CD, and our standard mark-up. Our success depends on continuous innovation and core competencies in new product development. We are under severe competition, and I am unable to meet the target of 15% ROI. We have an excellent reputation for our R&D capability and quality of products we bring to the market. Saleem Rashad (VP-CD): Ian, you know that we have nearly reserved 20% of our capacity to modify Alpha, price it and transfer to RD as needed. I am now operating at 80% of my nominal capacity that includes other products not transferred internally. My ROI expectation is in jeopardy if Ted (ID) purchases substitute products from France or Germany. The price of generic Alpha is set at $500 (Exhibit D). We should use my facilities and make a reasonable return for myself and for EEC.