Texas Products, Inc. is a decentralized company where each division is operated as an investment center and has its own production facilities and sales force (see Appendix for more information about transfer pricing). Division managers are paid well, including annual bonuses, and top management uses return on investment (ROI) to evaluate and reward the performance of its division managers. Two such divisions are the object of this case. The Midland Division has just won a contract for its recently developed product "Millennium." One of the component parts used in the production of Millennium can be manufactured by the Amarillo Division and has an internal code name of "Falcon;" however, a subcomponent functionally similar to Falcon can also be manufactured by outside providers. When bidding for the project, the manager of Midland Division, Luke Darth, asked Amarillo to provide the variable cost of the Falcon component and used the provided cost figure ($38.00) when preparing the Millennium bid. The Midland Division anticipates a total cost of $262.50 for the product (including the $38.00 cost of the Falcon component produced by the Amarillo Division) and won the contract with a bid of $362.50, which will be the Midland Division's revenue per unit sold. Variable manufacturing cost $168.00 (including $38 transfer price) Variable selling and distribution cost 31.50 Fixed manufacturing cost 63.00 TOTAL COST (MILLENNIUM) $262.50 The Amarillo Division's regular selling price for Falcon is $65.00 (to external customers). The sales force for Amarillo is actively pursuing new customers, and sales for Falcon are expected to increase. The Amarillo Division has the following costs associated with Falcon: Variable manufacturing cost $32.00 Variable selling and distribution cost 6.00 Fixed manufacturing cost 12.00 TOTAL COST [FALCON] $50.00 Unfortunately, the managers of the two divisions have not yet been able to agree on a transfer price for Falcon. The results of the negotiation will be important in determining which of the division managers earns a bonus this year. Ella Vader, manager of the Amarillo Division, is irritated that information was obtained about the cost of the Falcon component part without her knowledge. But she is thankful that whoever asked for the information did not specifically request "variable manufacturing cost," as the $38.00 cost figure provided to the Midland Division includes $6.00 of variable selling and distribution costs, which will not be incurred for any sales to Midland. Ella knows that she will not earn a bonus this year if her Amarillo Division effectively "gives" Falcon to Midland Division, which is what Amarillo would be doing if the transfer price is $38.00. She thinks that in order for her to earn an annual bonus this year, the transfer price for the component must be at least $58.20, which provides a 45% contribution margin ratio. But she has doubts that Luke Darth will be able to earn his annual bonus with a transfer price that high. IMA EDUCATIONAL CASE JOURNAL 1 VOL. 11, NO. 3, ART. 2, SEPTEMBER 2018 ISSN 1940-204X Texas Products, Inc. Nicholas J. Fessler Soules College of Business The University of Texas at Tyler 2018 IMA The Millennium product line is important for the Midland Division and for Texas Products, because it is expected to be critical for the future profitability of not only the division but also the company. Millennium, however, is less important for the Amarillo Division because sales of the Falcon component (and several other products) are steadily growing. Corporate management has no transfer price policy because interdivisional transactions have not previously occurred but has suggested the following possible transfer price methodologies for the Falcon component: a. Regular selling price, b. Regular selling price less variable selling and distribution expenses, c. Manufacturing cost plus 15%, and d. Variable manufacturing cost plus 20%. What can and/or should be done by Ella, Luke, and the corporate management of Texas Products with regard to Millennium and Falcon? REQUIREMENTS: 1. Compute each of the suggested transfer prices for (a), (b), (c), and (d). 2. Calculate the contribution margin ratios for both the Amarillo and Midland Divisions using the two transfer prices mentioned in the case: $38.00 used in the original bid, and $58.20 needed by Ella to earn her bonus. What conclusions do you draw from these calculations? 3. Is the negotiation of a price between the Midland and Amarillo Divisions an appropriate method to determine a transfer price? Is it likely that negotiation will be successful? 4. Should the corporate management of Texas Products become involved in this transfer controversy should negotiations between the two division managers break down? Explain.