Fizz-it, Inc. produces bottled drinks. The New England Division acquires the water, adds carbonation and sells it in bulk quantities to the California Division of Fizz-it and to outside buyers. The California Division buys carbonated water in bulk, adds flavoring, bottles it and sells it.

Last year, the New England Division produced 1,500,000 gallons of which it sold 1,300,000 gallons to the California Division and the remaining 200,000 gallons to outsiders for $0.20 per gallon. The California Division processed the 1,300,000 which it sold for $750,000. New England's variable costs were $220,000 and its fixed costs were $40,000. The California Division incurred an additional variable cost of $160,000 and $80,000 fixed costs. Both divisions operated below capacity.

Required

1. Prepare division income statements assuming the transfer price is at the external market price of $0.20 per gallon.

2. Repeat part a assuming a negotiated transfer price of $0.15 per gallon is used.

3. Assume the transfer price is $0.10 per gallon. (i) Consider the incentives of the New England Division. Given that the NE Division is trying to maximize its divisional profit, would it WANT to transfer the 1.3

million gallons at this price?

(ii) Recalculate the profit to the two divisions and for the company as a whole if the NE Division refuses to sell to the California Division, thereby forcing the California Division to purchase from external sources at a price of $0.20 per gallon.

4. Assume the transfer price is $0.25 per gallon. (i) Consider the incentives of the California Division. Given that the California Division is trying to maximize its divisional profit, would it WANT to receive and pay for transfer of 1.3 million gallons at this price?

(ii) Recalculate the profit to the two divisions and for the company as a whole if the California Division refuses to buy from the NE Division. (Assume that the NE Division can still only sell 200,000 gallons on the outside market.)

5. Respond to the statement: "The choice of a particular transfer price is immaterial to the company as a whole."

6. What if Fizz-Its selling division capacity is 1,600,000 gallons and the buying division wanted 1,500,000 gallons? What transfer price(s) policy would you recommend?