Please read Case 11-26 (page 534) and (1) calculate the acceptable lowest and highest transfer price when the Electrical Division is operating at its full capacity and (2) discuss whether the Electrical Division and the Brake Division could find an agreeable transfer price that would benefit the both divisions. In your discussion, please explain why or why not the two divisions may come to an agreement, and suggest possible remedies for the disagreement.
CASE 1126 Transfer Pricing; Divisional Performance LO113 @ Weller Industries is a decentralized organization with six divisions. The company's Electrical Division produces a variety Page 534 of electrical items, including an X52 electrical tting. The Electrical Division (which is operating at capacity) sells this tting to its regular customers for $7.50 each; the tting has a variable manufacturing cost of $4.25. The company's Brake Division has asked the Electrical Division to supply it with a large quantity of X52 ttings for only $5 each. The Brake Division, which is operating at 50% of capacity, will put the tting into a brake unit that it will produce and sell to a large commercial airline manufacturer. The cost of the brake unit being built by the Brake Division follows: Purchased parts (from outside vendors) $22.50 Electrical tting X5 2 5 .00 Other variable costs 14.00 Fixed overhead and administration Total cost per brake unit $49.50 Although the $5 price for the X52 tting represents a substantial discount from the regular $7.50 price, the manager of the Brake Division believes the price concession is necessary if his division is to get the contract for the airplane brake units. He has heard \"through the grapevine\" that the airplane manufacturer plans to reject his bid if it is more than $50 per brake unit. Thus, if the Brake Division is forced to pay the regular $7.50 price for the X5 2 tting, it will either not get the contract or it will suffer a substantial loss at a time when it is already operating at only 50% of capacity. The manager of the Brake Division argues that the price concession is imperative to the well-being of both his division and the company as a whole. Weller Industries uses return on investment (R01) to measure divisional performance. Required: 1. What is the Electrical Division's lowest acceptable transfer price? If you were the manager of the Electrical Division, would you supply the X52 tting to the Brake Division for $5 each as requested? Why or why not? 2. Assuming the airplane brakes can be sold for $50, what is the nancial advantage (disadvantage) for the company as a whole (on a per unit basis) if the Electrical Division supplies ttings to the Brake Division? Explain your answer. 3. What is the Brake Division's highest acceptable transfer price? In principle, should it be possible for the two divisional managers to agree to a transfer price in this particular situation? 4. Discuss the organizational behavior problems, if any, inherent in this situation. What would you advise the company's president to do in this situation
