Exercise 10-12

Transfer Pricing, Idle Capacity

Asgard Farms, Inc., has a number of divisions that produce jams and jellies, condiments, and glassware. The Glassware Division manufactures a variety of bottles that can be sold externally (to soft-drink and juice bottlers) or internally to Asgard Farms Jams Division. Sales and cost data on a case of 24 basic 12-ounce bottles are as follows:

Unit selling price	$2.30
Unit variable cost	$0.90
Unit product fixed cost	$0.70
Practical capacity in cases	500,000

During the coming year, the Glassware Division expects to sell 390,000 cases of this bottle. The Jams and Jellies Division currently plans to buy 100,000 cases on the outside market for $2.30 each. Bella Howard, manager of the Glassware Division, approached Paul Vining, manager of the Jams and Jellies Division, and offered to sell the 100,000 cases for $2.24 each. Bella explained to Paul that she can avoid selling costs of $0.12 per case by selling internally and that she would split the savings by offering a $0.06 discount on the usual price.

Required:

1. What is the minimum transfer price that the Glassware Division would be willing to accept? What is the maximum transfer price that the Jams and Jellies Division would be willing to pay? Should an internal transfer take place? What would be the benefit (or loss) to the firm as a whole if the internal transfer takes place?

2. Suppose Paul knows that the Glassware Division has idle capacity. Do you think that he would agree to the transfer price of $2.24? Suppose he counters with an offer to pay $1.60. If you were Bella, would you be interested in this price? Explain with supporting computations.

3. Suppose that Asgard Farms policy is that all internal transfers take place at full manufacturing cost. What would the transfer price be? Would the transfer take place?