Problem 1: Transfer Pricing (Issues with implementing Optimal Transfer Pricing) 1. Meta Computers has an Accessories division that produces various computer accessories and is evaluated on divisional profits. One of the accessories produced by the Accessories division is a graphics card. The graphics card is sold both to third-party distributors as well as transferred internally to the laptop division of Meta Computers. The Accessories division has the capacity to produce 100,000 graphics cards. External market demand for Meta Computer's graphics cards is 70,000. In addition, the laptop division requires 30,000 graphics cards. The accessories division sells the graphics card to third-party distributors at $600. Variable cost of producing a graphics card is $160 and fixed costs are $1.75 million. One of the parts of the graphics card is a memory card that is currently produced by the Accessories division. The variable cost of the memory card is $30 (note that this $30 is included in the total variable cost of $160). In addition, the memory card is manufactured using a cutting technology that is exclusively used for manufacturing memory cards. Currently, the Accessories division pays $750,000 to license this technology (note that this $750,000 is included in the fixed cost of $1.75 million). The current license for the technology is about to expire. The manager of the Accessories division is deciding whether to renew the license since a neighboring firm has offered to supply the Accessories division with the memory cards at $40 per memory card. a) Will Meta Computers prefer outsourcing memory card production? (2 points) b) If Meta Computers uses the optimal transfer pricing rule, will the manager of the Accessories division prefer to outsource the production of memory cards? (2 points) c) If Meta Computers uses full absorption cost as the transfer price for internal transfers, will the manager of the Accessories division prefer to outsource the production of memory cards? (2 points) A B D 1 Transfer Pricing Optimal Transfer Pricing Rule Full Absorption Transfer Price 2 3 Selling Price 4 Market Demand 5 Internal Transfer 6 Production Capacity (units) 7 Fixed Costs excuding licensing cost $600 70,000 30,000 100,000 $1,000,000 $600 70,000 30,000 100,000 $1,000,000 8 $130 $30 $130 $30 $750,000 $750,000 9 Option 1 (Fully In-House Production) 10 Variable Cost excluding memory card 11 Variable Cost of memory card 12 Total Variable cost of a graphics card 13 Licensing Cost (Fixed) 14 Transfer Price 15 Accessories Division Profits 16 Total Production Cost for Meta Computers 17 18 Option 2 (Outsource Memory Card) 19 Variable Cost excluding memory card 20 Variable Cost of memory card 21 Total Variable Cost of a graphics card 22 Licensing Cost (Fixed) 23 Transfer Price 24 Accessories Division Profits 25 Total Production Cost for Meta Computers $130 $40 $130 $40 $0 $0 26 a) Will Meta Computers prefer outsourcing 27 memory card? 28 29 30 b)lf Meta Computers uses the optimal transfer pricing rule, will the manager of the Accessories division prefer to outsource the 31 production of memory cards ? 32 33 34 c)If Meta Computers uses full absorption cost as transfer price for internal transfers, will the manager of the Accessories division prefer to 35 outsource the production of memory cards