The Duke Corporation bottles and sells various vegetable oils and preparations. It recently acquired a bottling plant and has been operating it as a separate division within Duke. So far, the Bottle division has been selling all its output to the external market directly. Duke has another operating division, the Safflower Oil division, which uses bottles similar to the ones made by the Bottle division. Both divisions are considered to be profit centers. Duke is structured as a decentralized organization and the Management of Duke believes that decentralization has improved the performance of the company as a whole. However, there are always opportunities to improve. The Safflower division has been unprofitable for the last few periods. To promote synergy's, the divisional manager of Safflower division is thinking of asking the divisional manager of Bottle division to supply the needs of the Safflower division. Current data for the two divisions are given below. After some analysis, the Bottle division agreed that the internal selling price per unit will be at the Minimum Transfer Price. (Lower than for external sales). The units are in dozens of bottles. The Safflower division's variable manufacturing costs include the price paid for bottles which is the same as the average selling price of the Bottle division. The manager of Safflower division believes that his division should get a discount on the price of the bottles if they are purchasing within the economic entity. The Divisional manager of Bottling has become aware that the divisional manager of the Safflower division will be approaching him to supply bottles to them. He is aware that the Safflower division requires about 80,000 dozen bottles. He discussed the issue with his marketing manager and the manager was of the opinion that Safflower should pay $3.00 per dozen bottles like everyone else. He indicated that their current sales projections were for sales of 300,000 dozen bottles. In order to meet the demand of Safflower they would have to give up sales to outside customer, which would negatively affect the division. He also stated that the Bottle division is not a charity whose role is to subsidize the weaker divisions, and more importantly, performance bonuses would be affected by this transaction.

Bottle Division Safflower Division

Capacity (Units) 320,000 80,000

Current Sales (Units) 300,000 80,000

Selling Price (average) per unit $ 3.00 $ 12.00

Variable Manufacturing Cost per unit $ 1.80 $ 9.00

Variable Selling Cost per unit for External Market $ 0.40 $ 2.00

Variable Selling Cost per unit if Sold Internally $ 0.20. $0

Fixed Costs $ 100,000.00 $ 116,000.00

The units are in dozens of bottles. The Safflower division's variable manufacturing costs include the price paid for bottles which is the same as the average selling price of the Bottle division. The manager of Safflower division believes that his division should get a discount on the price of the bottles if they are purchasing within the economic entity. The Divisional manager of Bottling has become aware that the divisional manager of the Safflower division will be approaching him to supply bottles to them. He is aware that the Safflower division requires about 80,000 dozen bottles. He discussed the issue with his marketing manager and the manager was of the opinion that Safflower should pay $3.00 per dozen bottles like everyone else. He indicated that their current sales projections were for sales of 300,000 dozen bottles. In order to meet the demand of Safflower they would have to give up sales to outside customer, which would negatively affect the division. He also stated that the Bottle division is not a charity whose role is to subsidize the weaker divisions, and more importantly, performance bonuses would be affected by this transaction.

After the marketing manager left, the Divisional manager of Bottle Division thought about many issues. He considered the fact that the main purpose of his division was to maximize shareholder value. To do he had to charge market after all his other customers were willing to pay $3.00 per dozen bottles, and in fact, the Divisions role was not to subsidize weaker divisions. Required The management team of the Duke has asked you to advise them regarding the appropriateness of the decision by the management of the Bottling Division A and the implications of the likely sourcing decision by the management of Safflower Division. Use the following case analysis format and section headings to address the requirements listed within each section. Point form is acceptable for the solution.

1. State and explain the issues faced by Duke Corporation. (4 Marks)

2. Alternatives: Identify the alternatives available to Duke. (2 Marks)

3. Data analysis: Prepare the appropriate transfer pricing analysis to assist Duke in determining the recommendation. HINT: Calculate Operating Incomes for both divisions under the scenario required. (6 Marks)

4. Analysis of alternatives and recommendation: Using the Data analysis in Part (3) above, make a recommendation for Duke Corporation. (2 Marks)