IN-CLASS TRANSFER PRICING PROBLEM Wallen Products Inc. has just purchased a small company that specializes in the manufacture of electronic tuners that are used as a component part of TV sets. Wallen Products is a decentralized company, and it will treat the newly acquired company as an autonomous division with full profit responsibility. The new division, called the Tuner Division, has the following revenue and costs associated with each tuner that it manufactures and sells: Selling price $20 Expenses: Variable $11 Fixed (based on a capacity of 100,000 tuners per year). 6 17 Operating income $ 3 Wallen Products also has an Assembly Division that assembles TV sets. This division is currently purchasing 30,000 tuners per year from an overseas supplier at a cost of $20 per tuner, less a 10% purchase discount. The president of Wallen Products is anxious to have the Assembly Division begin purchasing its tuners from the newly acquired Tuner Division in order to "keep the profits within the corporate family." Required: For (1) and (2) below, assume that the Tuner Division can sell all of its output to outside TV manufacturers (Le., no excess capacity) at the normal $20 price. 1. Are the managers of the Tuner and Assembly Divisions likely to voluntarily agree to a transfer price for 30,000 tuners each year? Why or why not? Assembly's max purchase price = $20 - (10%*$20) = $18 Turner's min selling price = Variable cost + opportunity cost = $11 + ($20 - $11) = $20 No, because the buyer's max price is lower than the seller's min price. . . . A solution to this question has been requested by another student. It will be ready shortly. 2. If the Tuner Division meets the price that the Assembly Division is currently paying to its overseas supplier and sells 30,000 tuners to the Assembly Division each year, what will be the effect on the profits of the Tuner Division, the Assembly Division, and the company as a whole? Turner = ($18 - min selling price)*30,000units = ($18 - $20)*30,000units = -$60,000 Assembly = $0 (indifferent about who they buy from) Company = -$60,0003. Now assume Tuner Division has excess capacity to make 40,000 units and Assembly Division's supplier drop's its price to $16 per tuner. Should the Tuner Division meet this price? What is the impact on overall company profits if they don't? Assembly's purchase price = $16 Turner's min selling price = Variable cost + opportunity cost = $11 + ($0) = $11 Yes, because it has positive effects on division profit: = ($16 - $11)*30,000 = $150,000 This will also increase company profits by $150,000. 4. Again assume Turner Division has excess capacity to make 40,000 units. If the Tuner Division won't accept $16, then should Assembly be forced to pay a higher price to Tuner Division? Why or why not? Yes, because the firm is economically worse off if the deal does not happen at $16. No, because it undermines the division manager's authority and autonomy